Controlling inflation while promoting 'real growth' is a tricky balancing act. The government cannot use "blunt instruments" to bring down inflation, says Kaushik Basu, the outgoing chief economic advisor, in the second part of interview to Gautam Chikermane.
Gautam Chikermane: Over the past three years, inflation has only been going up and staying up. All effects, like base effect or any statistically-manipulable effect, are over and we are holding on to very high prices that hurt the poor the most as they move down the food chain. What's going on? Why are we not able to control inflation, particularly food inflation?
Kaushik Basu: First the facts. Inflation in early 2009 had gone down. By late 2009 inflation was up. By early 2010, food inflation had crossed 20%. After that it came down quite a bit. But it's a fluctuating decrease. Food inflation is now around 10%. In managing inflation, you have to understand that this is one area where it is not the lack of intention on part of politicians or RBI that causes it. Inflation is a partially-understood discipline.
Gautam Chikermane: What does "partially-understood" mean?
Kaushik Basu: Recently, I had long meeting with Australian policy makers at Canberra. Australia used to be like us, inflating at 15-16%. It has now gone down to 2% or less. How did it happen? While it is evident that Australia has put in an impressive amount of talent into its economic policymaking, I don't think anybody fully understands what led to this amazing success. Unlike other variables, inflation is not something that any politician wants. It hurts their electoral prospects. So it's a genuinely-difficult policy problem.
Gautam Chikermane:How do you fix it?
Kaushik Basu: There are some blunt instruments which you can use which will have big, dampening effects on growth but can bring down inflation. But we don't know the consensus on how much of dampening of growth is acceptable to bring down inflation. Also, we must remember that a growth slowdown will come with increasing unemployment. Let me point out that when we consider the historical record of inflation around the world, India does not come out poorly. Our central bank has an impressive track record of policymaking.
Gautam Chikermane: And failing!
Kaushik Basu: Failing is the wrong word because inflation comes from multiple sources, many that are beyond the control of government or the RBI.
Gautam Chikermane: That's alarming.
Kaushik Basu: Maybe, but it is fact. And denying facts is not a good way to proceed. I'll give you two examples. In a globalised world money being created in country X flows into country Y with an ease that was never there before. Earlier, RBI controlled our liquidity, US Fed controlled US liquidity, BOJ controlled Japan's liquidity. But in today's world, the US Fed generating liquidity comes flooding into other markets, including India's. So our liquidity is not fully within our control. Secondly, when we go for financial inclusion, we enable poor people who used to hold their money and keep it under the pillow, to put it in the banking system or mutual funds. This is good and we should do it. But it also means creating money supply because money that was effectively withdrawn from the system is injected back into it. So, even if RBI and the government did nothing else but ordinary people start putting their money in the bank, this will create an upward pressure on prices because the effective supply of money in the economy would go up.
Gautam Chikermane: This leads me to a question that addresses the growth-inflation mix. Are we happy with 4% inflation and 5% GDP growth or is it better we go for 10% inflation and 11% GDP growth?
Kaushik Basu: My answer is easy. We should go for 10% inflation and 11% GDP growth. After all, 11% GDP growth is real growth; so people are every year better off by 11%. If this is equitably distributed across the population, then it is fine even if it means that we have to tolerate a higher inflation. South Korea, which took off in huge way during 1970s, was inflating at around 20% per annum. But it was also producing more in leaps and bounds. So it was vibrant economy with large inflation. We should not aim for that, but if we have to live with a little higher inflation to get greater growth, I would go for that rather than holding back people in poverty just to keep inflation down.
Gautam Chikermane: But we seem to be moving towards the previous option, that we temper growth to control inflation. Or worse, we temper growth but inflation stays high and we move to stagflation. I think we are falling in an intellectual-policy trap.
Kaushik Basu: I disagree with that. A 6.5% GDP growth, with even 10% inflation is not stagflation. This is real growth taking place. Nominal growth is occurring at around 17% and inflation is eroding only a part of that. But we are still growing at 6.5% in real terms after you remove the inflation. That is not stagflation.
Gautam Chikermane: Is this view of high growth and high inflation the general political view?
Kaushik Basu: I can't say so because the general political view is often quite chaotic. But if everybody thought clearly, they would all agree with me. Whether everyone has that clarity of thought I don't know.