The factor that seems to have slipped under everybody’s radar screens is that since the mid-2000s, there has been a steady shift in the terms of trade on two different planes. The first is about the shift in the terms of trade away from manufacturing and in favour of agriculture.
In other words, there is a redistribution of income happening from urban areas to rural areas. This is pretty much borne out by data that suggests the growth rate of production has been lower in rural areas than in urban areas, but the growth rates of income are roughly the same over this period.
The second thing that has happened in rural areas is that for a variety of reasons, in which the National Rural Employment Guarantee Scheme (NREGS) has an important role to play, there has been a shift in income distribution away from the landed class to the landless labour.
Rural wages have gone up faster than rural agricultural prices. This has led to a situation where the shift in terms of trade is essentially a shift in income away from relatively high savings groups to relatively high consuming groups.
The rural population has a higher propensity to consume than their urban counterparts, and within rural areas the landless labourer has an even higher propensity to consume than the land-owning farmer. This is also happening pretty much across the board.
India is beginning to see a substantial increase in consumer demand at a localised level. Earlier, all marketable surpluses in farm products was taken to the mandi and sent off to the urban areas.
There was very little rural-to-rural marketable surplus. Now the surplus available for urban areas is down because of greater rural absorption. That is at the heart of the problem.
The food inflation we are witnessing has its origins in this phenomenon.
One way to tackle food inflation is by stopping the income transfer happening to rural areas — which is not a good thing because this transfer is exactly what the UPA government wants as a development policy.
The alternative is to recognise that rural demand has gone up and make the chain of food supplies from the mandi to the urban consumer more efficient. This is where foreign direct investment in retail comes in.
Once we recognise that people in rural areas are demanding stuff that they did not consume earlier, we really have to take a serious look at rural food sales.
We know a lot about mandis: there is strong data collection at that level. But we don’t know much about what is happening at the haats, which is where the rural transactions take place.
India must to go beyond traditional assumptions, integrate haats into the way it thinks about the food economy and work out how to make that process more efficient.
The immediate challenge is to prevent the rise in food prices from spilling over to wages. Higher food inflation will lead to higher wages — the classic wage-price spiral.
I am tempted to believe that we entered into the wage-price spiral probably by the end of 2010 and in the next two years there have been extraordinarily large wage settlements in industry, some in the range of 24-26%.
Around the same time, industry also ran into a serious skills shortage. There were particular sections within the labour market whose bargaining power jumped manifold simply because of the skills they possessed.
This, pretty much, played out across industries. The wage-price spiral has begun to play down since the beginning of 2012-13, although the hangover could persist for a while.
One of the ways industry absorbs high labour costs is through productivity increases. The slowdown over the last few quarters has implied that investment, particularly in large projects, has come down.
What, however, is more important is to find out whether corporate India’s investment in technology has slowed. Not much is known on this front.
India has now come to a situation where consumption growth has accelerated at a very fast clip. This is partly because of shifts in income distribution but also partly because the government has been running a large revenue deficit.
The government has to take a call on how and when it will shift away from indirect subsidies such as those given on petroleum and fertilisers and in favour of direct ones such as the NREGS.
In my mind, the single most important thing that finance minister P Chidambaram should address in the budget is narrowing down the revenue deficit.
It has implications for prices and it has implications for growth. Since it is now very clear that the goods and services tax is not going to come in this year, there is a strong case for raising the standard excise duty from 12% to 14%.
It is incorrect to argue that higher excise duties will be inflationary. Higher taxes will lead to a contraction in demand, and may actually help contain inflation.
Finally, it is also about time to bring back the Direct Taxes Code in its original form, which embodied a philosophy. The finance minister, I would guess, would make some announcements on these lines in the budget.
Pronab Sen is former principal economic advisor to the Planning Commission
The views expressed by the author are personal