Paradox Of Growth And Inflation in India

Posted in Finance Articles, Total Reads: 2413 , Published on 01 January 2014
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On 4th September 2013 Raguram Rajan took the control of Reserve Bank of India as 23rd Governor. On the very first day in his office; he tried to address the paradox that his predecessor was trying to address since 2008 “Paradox of Growth and Inflation”. He announced number of financial reforms to control the rupee depreciation, inflation and to unveil animal spirit of Indian economy.

Image Courtesy: Kittisak, freedigitalphotos.net


All RBI governors, while deciding the direction of monitory policy, tried to draw a direct correlation between Growth and inflation. However historical data present a different picture.



High growth invites high inflation; this is the underline assumption, however above graph shows it is not always true. Inflation in India has always remained on higher side except for the period 2000 to 2006. In past five years this high inflation is caused by endogenous and exogenous factors. Main reason of inflation in India is food inflation. Food prices (endogenous) in India are continuously increasing, changing eating habits and focus on high protein diet putting pressure on supply side(Refer table below). Government has also played equal role in food inflation. Contribution of government in farm production is exponentially decreasing. From 1947 to 1980 government’s contribution was around 40%, 1980 to 2000 it reduced to 24% and in last decade it was only 18%. Increasing minimum support price (MSP) and storage of food grains by government and archaic Agricultural Produce Marketing Act (APMC) has played a major role in the food inflation. MSP on paddy in last decade has increased at CAGR of 10.3% and it has increased by CAGR of 13.2% on wheat. Populist government schemes have forced government to procure more food grains; this has caused less supply in open market and less grains for export. Major part of the procured food grains is left for rotting in absence of proper food storage capacity at Food Corporation of India.


Provisional all India annual inflation rates (%) for July 2013

Category

Rural

Urban

Combined

July 12

Index

Final

July 13

Index

Prov.

Rate

(%)

July 12

Index

Final

July 13

Index

Prov.

Rate

(%)

July 12

Index

Final

July 13

Index

Prov.

Rate

(%)

1

Cereals  and  products

113.4

130.1

14.73

109.1

130.8

19.89

112.3

130.3

16.03

2

Pulses  and  products

109.5

116.9

6.76

111.1

114.4

2.97

110.0

116.1

5.55

3

Oils and  fats

135.9

142.4

4.78

144.3

142.7

-1.11

138.6

142.5

2.81

4

Egg, fish and  meat

126.3

141.8

12.27

125.1

146.3

16.95

125.9

143.3

13.82

5

Milk and  products

130.6

141.6

8.42

126.2

136.0

7.77

129.0

139.5

8.14

6

Condiments and spices

123.6

132.1

6.88

119.8

130.5

8.93

122.5

131.6

7.43

7

Vegetables

138.9

155.8

12.17

135.4

170.3

25.78

137.8

160.4

16.40

8

Fruits

137.6

148.8

8.14

141.9

149.2

5.14

139.5

149.0

6.81

9

Sugar etc

103.5

110.3

6.57

104.5

106.9

2.30

103.8

109.3

5.30

10

Non-alcoholic beverages

122.1

132.9

8.85

120.6

135.2

12.11

121.5

133.9

10.21

11

Prepared meals  etc

121.7

132.7

9.04

121.7

135.3

11.18

121.7

134.0

10.11

12

Food and beverages (1 to 11)

122.8

135.9

10.67

122.8

138.0

12.38

122.8

136.6

11.24

13

Fuel and light

125.2

135.2

7.99

121.8

132.8

9.03

123.9

134.3

8.39

14

Clothing, bedding and footwear

128.5

140.7

9.49

129.6

141.5

9.18

128.9

141.0

9.39

General Index (All Groups)

122.6

133.8

9.14

119.9

132.2

10.26

121.4

133.1

9.64


























India’s current account deficit is widening every year. After suffering the downgrades from major rating agencies borrowing from outside has become expensive for Indian industry. Widening CAD signals government will take more money from the market and banks; it puts inflationary pressure on economy. India has borrowed heavily from outside to fund the CAD which is now showing its impact in terms of inflation. To tame this inflationary pressure RBI kept on raising the key policy rates and started addressing demand side. RBI kept high repo rates to squeeze the money from the system. From April 2012 to Jan 2013 RBI kept policy rate unchanged. RBI’s main objective was to address the inflation and for which it was ready to scarify the short term growth




Growth rate slowed from 9.3% to 6.3% from FY 11 to FY 12 but the inflation went up from 6.49% to 11.49% during same period. Now an important question for the new governor, Raghuram Rajan, is whether monetary policy has lost its credibility and effectiveness in tackling “inflation and growth paradox”? While interest rate is one of the instruments to control the inflation, but to balance the growth along with inflation RBI and government should work in tandem. While RBI can ease the policy rates for good growth, government can reduced the import of non essential commodities to reduce the Current account deficit. Current account deficit in financial year 2012-13 was 4.8% of GDP. If we remove the import of Gold and oil, the CAD still remain as high as 3.8% of GDP. India imported $30 billion of electronics good alone in last financial year. Tax and import duty on electronics goods such as T.V. and refrigerator in India is way below the WTO standard. It is the right time when government of India and RBI work together on above mentioned issues and create an environment to resolve the “Inflation growth paradox”.


This article has been authored by Roshan Khatri from IIFT


Sources:

http://www.inflation.eu/inflation-rates/india/historic-inflation/cpi-inflation-india.aspx

http://mospi.nic.in/mospi_new/upload/t4.pdf

http://www.finmin.nic.in/

www.rbi.org



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