Indian economy is caught in the classic wage-price spiral

If any more proof is needed that runaway inflation isn’t going to disappear anytime soon, here it is. The Hindu Business Line reports that the Centre is about to raise minimum support prices (MSP) for kharif crops by 15-17 percent on the recommendations of the Commission for Agricultural Costs and Prices (CACP).

The rise is intended to compensate farmers for rising input costs, including fertiliser and labour. The agriculture ministry has proposed raising the MSP for paddy to Rs 1,160 from Rs 1,000 a quintal for crops coming to the market in the 2011-12 season - that is, towards the year-end. The oilseeds hike (soya and groundnut) recommended is 17 percent, while cottonseed (kapas) gets 10-12 percent and coarse grains 11.4 percent. Price hikes in pulses are reportedly lower, the newspaper reported.

While there is little doubt the government is going to accept the recommendations given its political inability to withstand any pressure group- least of all farmers, whose cause Rahul Gandhi is now championing in Uttar Pradesh over compensation for land acquisition - raising MSPs by 15-17 percent is not going to do the cause of lowering food price inflation (8.55 percent around mid-May) any good.

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On the contrary, the government is setting itself up for the classic wage-price spiral - where prices and wages chase each other till growth comes down and lowers inflationary expectations.

[caption id=“attachment_17924” align=“alignleft” width=“380” caption=“The minimum support price hike is partly the result of rising farm wages. As wages rise, more money will be spent on food, driving up food inflation. Photo by Ramon Casha.”]  [/caption]

There is strong evidence that the MSP hike is partly the result of rising farm wages, which are once again the result of social security schemes like NREGA (National Rural Employment Guarantee Act). According to another report in Business Line, farm wages in 2010 were up by an average of 15-25 percent, especially in the agriculturally important states of Punjab (32 percent), Andhra Pradesh (28 percent), Karnataka (28 percent), Haryana (16 percent), Maharashtra (26 percent), Madhya Pradesh (21 percent), Tamil Nadu (26 percent), Uttar Pradesh (23 percent) and West Bengal (19 percent). Orissa, a traditional supplier of migrant labour to other states, saw wages rise by a phenomenal 43 percent.

Quite clearly, as wages keep rising, more money will be spent on food, driving up food inflation. This will spur demand for higher wages. NREGA wages are already indexed to inflation. This is where the decision to raise MSP will add fuel to the fire. Considering the fact that the government is yet to raise diesel prices, we are nowhere near the end of the price-rise game.

Where will it all end? A wage-price spiral cannot continue forever - or we will all price ourselves out of food and necessities. The only way this is going to cool down is through slower economic growth. While official forecasts are still talking of growth in 2011-12 slowing to around 8 percent, Morgan Stanley’s Asia-Pacific Economist Chetan Ahya says his organisation has already cut growth forecasts twice for India and it now stands at 7.7 percent.

So batten down the hatches. India is slowing down for sure.