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Mismanagement, not 9% growth is the culprit

Bimal Jalan says there is no defined range for countries on the correlation between inflation and economic growth. Saikat Neogi reports.

india Updated: Feb 20, 2007 12:18 IST

India is an inflation-sensitive nation. In the 1970s the country had 8 per cent inflation, but GDP growth was only 3.5 per cent. In the 1980s and 1990s, though GDP growth was 5 per cent, inflation was around 9 per cent. Inflation dipped to 4 per cent couple of years ago and GDP grew to 8 per cent.

Bimal Jalan, former governor of Reserve Bank of India says there is no defined range for countries on the correlation between inflation and economic growth. “The current rate of inflation is higher than the central bank’s target of 5 to 5.5 per cent and the spike is due to a supply side problem,” he says and cautions that there are signs of overheating in certain sectors of the economy.

Consumers are feeling the pinch as the prices of vegetables and pulses have risen by 29 per cent and 24 per cent respectively on a year-on-year basis. The wholesale price index of food grains has increased by 10 per cent and steel and cement prices have jumped 15 and 16 per cent respectively.

The sudden rise in prices is the outcome of both domestic supply shocks and demand-pull pressures. Rupa Rege Nitsure, Bank of Baroda’s chief economist says that the domestic supply shocks are evident in increasing shortages of food grains, pulses and vegetables. “Demand pull pressures are reflected in the increasing inflation rate for manufactured products.”

There is a consensus among economists that Indian agriculture faces constraints. With rising per capita incomes, farm demand has outpaced supply. For example, since the late 1990s, food grains production has stagnated in the 195-213 million tonne range. Production of pulses hasn’t budged for two decades.

Public investment in agriculture, a means to boost production, has fallen from 14.9 per cent in the first Five Year Plan to 5.2 per cent in the current plan. This has had an adverse impact on irrigation as only 40 per cent of the land under cultivation is irrigated.

Is higher growth rate and falling farm output the only reason for rising prices? Jayati Ghosh, an economist with the Jawaharlal Nehru University disagrees. “The recent rise in inflation is not due to higher growth but by economic mismanagement.” She explains that the government allowed the entry of private players into the grain trade and opened up the futures market for trading in essential commodities, which have a history of being hoarded.

To combat the current two-year high inflation, the government reduced import duties on some items and lowered petrol and diesel prices. The RBI raised its lending rate and hiked the cash reserve ratio, the amount of money banks need to keep with the central bank. But will these short-term measures help?

Tightening liquidity can hurt growth, as access to affordable credit has been a growth driver. Jayati Ghosh says hike in lending rate has a negative effect on small enterprises. “Instead of blanket measures, there should be direct interventions in sectors where speculative bubbles are visible like the real estate and stock market.”

Bank of Baroda’s Nitsure feels that the RBI’s measures will control credit flows going to overheated sectors, but in the long run to keep inflation within the tolerance level, the government will have to address the agriculture sector.

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First Published: Feb 20, 2007 12:18 IST