It's official: Rahul-flation is now seen as stagflation

High social spending, unsustainable subsidies and pandering to the farm lobby have now led to stagflation. Says who? The PM's economic advisor.

R Jagannathan December 20, 2014 16:36:20 IST
It's official: Rahul-flation is now seen as stagflation

It is part of the Prime Minister's job, and also that of the Finance Minister, to talk up the economy, but one wonders if it is any part of their brief to offer misleading statements.

In Parliament today, Manmohan Singh laid the blame for the economy's slowdown largely on external factors, and made only minor references to his government's follies at home.

His Finance Minister, P Chidambaram, admitted that inflation was partly the result of government policy action (higher economic stimulus and big jumps in minimum support prices for foodgrain), but chose to trumpet these as a political boon to farmers.

An economist whom both Manmohan Singh and P Chidambaram respect has now punctured their pretentions: C Rangarajan, Chairman of the PM's Economic Advisory Council has said that India is now into stagflation: an unholy mix of both slowdown and high inflation.

Firstpost has talked of stagflation several times. As early as in September 2011, we had flagged off the issue of excess government spending and dubbed it Rahul-flation - inflation driven by populist spending with the goal of enabling Rahul Gandhi to become PM at some time in the future.

Last year, Rahul-flation was metamorphosing into something closer to stagflation. We had specifically predicted that while price pressures will be upwards, growth will start flagging, leading to stagflation. As things stand, our growth rate is less than half our consumer inflation rate.

Now, of course, it is being officially acknowledged by Rangarajan.

But is the PM aware of the bid we are in? This is what he told parliament today:

"It is certainly true that in the last two years there has been a slowdown in the economy and it has been reflected in the GDP. In the Economic Survey of 2012-13 and the Finance Minister's budget speech, we have explained at length the factors that are responsible for the slowdown."

And the factors he mentioned as important were the global financial crisis of 2008-09 and the eurozone crisis of 2010-11. He added: "These things do affect the economy. There were domestic issues as well. We are trying to tackle the crisis."

He expected the economy to get back to a "robust growth path" in two or three years.

It was left to P Chidambaram to flag the domestic contributors to the crisis - but even he used the occasion to thump his political chest and pretend that failures of policy were, in fact, successes.

Chidambaram followed the Manmohan line of blaming most of it on the external crisis, even though the problems were accentuated by the quality of the domestic response. He said: "It is not a correct assessment that we were not affected by the 2008 banking crisis."

Following the crisis, the "government gave stimulus packages for three years which gave us high growth. But this resulted in an increase in the fiscal deficit, which in turn led to high inflation."

Then, in a partial admission of another UPA-induced contributory factor to inflation, he said: "CPI (consumer price index) is driven by food inflation. Cereal inflation is high because of high MSP (minimum support prices), Pulses inflation is high because of demand and supply gap."

But was this a tacit admission of faulty MSP policies?

Not quite, for Chidambaram trumpeted it as a triumph. He said: "No government has doubled the MSP in five years. The NDA government had hiked MSP at the rate of Rs 10 per year,"

In short, he is saying that the NDA was more prudent in managing inflation by curtailing MSPs, but he would rather claim success in artificially raising farmers' earnings at a time of overflowing godowns even if it has damaged the economy's medium-term growth prospects.

The latest CPI figures for February show a rise in the index from 10.88 percent to 10.91 percent. Food, beverages and tobacco, which account for nearly half the index weight, rose 13.71 percent. But core inflation (non-food, non-fuel inflation, which measures the economy's underlying inflationary potential) was as high as eight percent.

With fuel prices set to keep rising in a bid to contain subsidies, the cost-push pressures on CPI will remain steady through 2013. Rajeev Malik, Senior Economist at CLSA, writing in Business Standard, says "India has become a low growth-high inflation economy (officials remain in denial), and the macro healing will be protracted and uneven."

Malik's views have now found an official echo in Rangarajan. Writing in the February issue of rating agency ICRA's Bulletin of Money and Finance (along with Alok Sheel), Rangarajan notes that "stagflationary tendencies have already reared their head in emerging markets like India."

Its official Rahulflation is now seen as stagflation

According to Rangarajan, "India may need to cool consumption and clear supply side bottlenecks by switching public expenditure from subsidies to investment. This would help raise the growth potential and lower inflation over the medium term."Reuters

More interesting is Rangarajan's analysis of why this has happened. While Chidambaram put it down to the extra stimulus spending in the post-2008 period, Rangarajan suggests that the problems went back further, to the expansionary years of UPA-1.

Before 2008, when tax revenues were buoyant, the fiscal policy should have been tighter so that there was room for spending more when the business cycle turned down. But Chidambaram loosened fiscal policy in 2008 in the run-up to the election, but robbed the exchequer of leeway subsequently.

Rangarajan, of course, says this more indirectly. "India's fiscal policy in the run-up to the (2008) crisis was also not contra-cyclical, with the fiscal improvement mostly on account of the positive revenue shock induced by above trend growth than by expenditure reform through reducing subsidies. As a result it also quickly ran out of fiscal space as growth declined."

Put another way, today's fiscal clean-up that Chidambaram is trying to do is his own legacy.

Equally important is Rangarajan's caution on increasing entitlements in social schemes when the going is good. Though he was addressing this piece of advice to the advanced countries, which have run up unmanageable welfare budgets, the advice applies equally to UPA's intractable increases in welfare spending.

Rangarajan wrote: "But quite apart from following a contra-cyclical fiscal policy, another object lesson from advanced countries is that generous social compacts are difficult to renegotiate. It is, therefore, imprudent to put in place generous compacts that are affordable when societies are young and trend growth is high, but become unaffordable as society ages and growth moderates."

Our society has not aged, but our growth has certainly moderated.

Rangarajan also explains why, despite high interest rates, inflation is not coming down.

"The first lesson to be derived from the policy response to the current crisis in advanced economies is that while monetary policy is a powerful macroeconomic tool for stabilising business cycles, it cannot revive growth by sweeping structural problems under the carpet."

He was talking about the US, but he underlined the India angle thus: "India too is finding that monetary policy is no magical tool to revive growth in an economy beset with structural market rigidities, high fiscal deficits and inflationary expectations. In these circumstances monetary policy can only play a limited role."

Translated, this means lower interest rates won't deliver the goods without the right kind of fiscal correction.

According to Rangarajan, "India may need to cool consumption and clear supply side bottlenecks by switching public expenditure from subsidies to investment. This would help raise the growth potential and lower inflation over the medium term."

But in 2012-13, Chidambaram did the opposite: cut plan expenditure and not subsidies. For next year, Plan spending is to rise more significantly, but he has also underprovided for subsidies.

India's stagflation, it seems, is here to stay till we find a way to stimulate growth without stoking inflation.

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