We can have growth or low inflation, not both

The government is struggling to raise indirect taxes, and it will require much larger inflation to get anywhere close to budget estimates, more so when the growth estimates have been downgraded

The ex-food inflation was trending down for some time. There was an increasing clamour for lower rates until Reserve Bank of India (RBI) took liquidity tightening measures in July to stop the rupee from sliding. So, will it be fair to say that markets forced higher interest rates and possibly higher inflation, ex-food, on the Indian economy?

If yes, the corollary question is whether economic forces will let India have low inflation sometime in the near future, assuming, of course, that we wish to grow at over 6%?

We are not about to get into some hyper-mathematical regression analysis of data to come to any conclusion. However, here is an attempt to use some basic data points and commonsense logic to ask simple questions. Let us first take up some tax numbers.

Refer to the chart below.

We all know the Central government fiscal deficit has been going out of control. It has been funded through huge borrowings, which have been helped by the massive Open Market Operations by RBI, amongst other things. The liquidity addition operations has not only helped government maintain some sanity in money markets but also pumped up inflation. The nominal GDP (GDP+inflation) numbers reflects that.

Inflation also helps government on the tax revenue front. Some tax rate hikes (from 2009 levels) along with inflation has led to huge jumps in indirect taxes. So far, corporates/banks have also been able to pass on the cost pressures and maintain profitability. It has helped direct taxes as well.

While core manufacturing inflation slowed down through FY13 and index of industrial production (IIP) numbers were not reflecting any major growth. Excise collections kept good pace. But that was because rates were hiked from 10% to 12%, which may look small but takes collections up by 20% on a standstill basis. The same applies to service tax collections as well.

With no such hikes for FY14 in the first five months, the government is struggling to raise indirect taxes, and it will require much larger inflation to get anywhere close

to budget estimates, more so when the growth estimates have been downgraded.

That has meant that the fiscal deficit has gone haywire, in absolute terms, reaching almost 75% of the full year target by August itself. The other thing is that since nominal GDP is trending lower than estimated, the denominator for the 4.8% of GDP fiscal deficit calculation could be lower, hurting it there as well.

Can the government really afford low, ex-food inflation?

(Let us also keep in mind, 7^th Pay Commission and Food Security Bill are not very far into the future!!)

If the government revenues struggle due to low inflation, what about the corporates? Lot of corporates, particularly in the commodity and infrastructure space, are hugely leveraged. Reasons for their present state of affairs could range from mismanagement to fraud to bureaucratic/regulatory overbearance. But the end result is that most of them will find it difficult to participate in further bids or plan new capital expenditure except the routine ones. Even if they are not leveraged, they need to be incentivised through better returns given the risks of doing business in India.

What they will need is higher prices for their end products or services!!

(Land Acquisition Bill only worsens the requirements)

If we really want Indian Railways to be a self-sustaining operation and not become another “Air India” or “BSNL”, clearly the passenger fares and tariffs need to go up, maybe at close to double digits, on a per annum basis, or costs have to come down.

State electricity boards (SEBs) were ultimately forced into taking hefty price hikes. And it still doesn’t look like they are in any kind of self-sustenance mode.

In spite of having raised prices, under recoveries on petro-products are huge and sooner or later they have to go up.

Where is low inflation here?

Ground water levels across the country are witnessing downward trend. There is evidence of “water mafia” in operation, particularly in water short regions or summer times. Sooner or later, water whether for urban, agricultural or industrial consumption will need to be priced properly, directly or indirectly.

If our rivers have to be rescued, increased number of waste treatment plants along with other steps, will be a must. All these will only add to the cost of operating businesses or households. A good monsoon can only postpone problems by a few months, not resolve issues.

There might be other examples with similar setups and which ultimately will require higher funds and correspondingly higher prices for products and services.

Rupee depreciation was market’s way of trying to balance some of these issues besides the obvious ones on the current account deficit front. It forces government to control fiscal profligacy and reduce subsidies. By trying to influence currency markets through some unnatural policy steps, we are only hampering what maybe the market’s balancing act and may worsen the situation.

The government may not like the fact that the balancing act is bringing inflation up. But how else do you get out of a socialistic, subsidy and deficit driven setup that has been created over last few years?

(There could be some argument on how lower oil prices could change lot of things, and there is no denying that. But, as of now, we can just take the current market price as it is and analyse. If lower crude prices follow, we can only be better off)

Our government and quite a few corporates, big and small, are leveraged. Both are needed to shape up to setup things for faster growth in times ahead.

And inflation generally favours the borrowers.

Will the market forces let India have low sustaining inflation any time soon?

Agriculture is not taxed heavily in India. So, low food inflation should not hurt revenues much.

Could low food inflation and reasonable non-food inflation be the ideal mix?

We seem to have exactly the opposite right now!

 
              Share It & Spread It 
 

______________________________________________

                          ♦ Subscribe And Be Updated Yourself ♦ 
                      ♦ ♦  www.pullaharshavardhan.blogspot.in ♦ ♦ 
                               ♦ ♦ ♦ Be a FAN In Facebook ♦ ♦ ♦ 
______________________________________________