It's the economy, stupid. Why UPA won't have it easy in 2014

Food inflation is heading towards double-digits again. But the Chairman of the Prime Minister’s Economic Advisory Council (EAC), C Rangarajan, is telling us that “if the monsoon is favourable, food prices will come down over the next two-three months.” The good doctor also assures us that “overall inflation will come down slowly by October-end.”

“Slowly” is the only part of the sentence one can agree with. The Reserve Bank, the finance ministry, the EAC and sundry economists have been getting their inflation numbers consistently wrong for over two years now- and they do not seem to be re-examining their premises.

Not that any economist can be consistently good at crystal-ball gazing, but few seem to have noted that something fundamental has changed in the first five years of the UPA. They are making predictions about inflation and growth as though we are still in the 1990s.

Here’s the crux of the problem: Wages and prices, both in rural and urban areas, are into an upward spiral. And this is happening even without passing on the full impact of oil price increases to consumers. This means the push of cost will continue to exert an upward pressure on prices for years to come.

Rising wages is making farming unviable without regular and sharp increases in agricultural prices. It is also pushing up urban wages, as more workers choose to remain in their village redoubts. This is driving up urban costs. You can’t find a carpenter or plumber in Mumbai or Delhi at the old rates anymore. This is pushing up costs in the real estate and infrastructure sectors- two of the biggest employers in the country.

On the other hand, both monetary and fiscal policies are currently geared towards economic contraction. This means slower growth, lower tax revenues, pressures on corporate profitability, and shrinking asset prices (stocks and real estate). Given the atmosphere of scams and political gridlock, investments are slowing down, too. Falling foreign direct investment is one indicator.

Inflation and growth in the short-to medium-term will depend on how these two spirals- the upward spiral of cost and the downward pressure on growth-play out.

Our best guess is that the measures to douse inflation will reduce growth and take us back to the 7% annual GDP growth level over the next two years, unless the government gets going on reforms. Serious reforms are needed in retail (to cut the inefficiencies in the food supply chain) and in agriculture to raise farm productivity (which may mean more investments in irrigation, better seeds, GM crops, et al). Or else how will food supplies ever match higher demand?

But we can’t get any of these medium-term measures going because the UPA government has tied itself in knots over the introduction of Genetically Modified (GM) crops, big dams, power and mining projects, and everything else there is.

Fiscally, the finance ministry is committed to reducing fertiliser subsidies, and oil subsidies have to go sooner or later. The latter two measures will have the opposite effect on agricultural productivity in the short term.

In the meanwhile, Sonia’s Gandhi National Advisory Council (NAC) is planning to extend the Food Security Act to 75% of the population.

The scenario is, thus, one of rising demand for food due to the Food Security Act and rising safety net payments to the poor. As we approach the 2014 elections, the government will only be stepping up spending on these programmes and not reducing them.

Where does that leave us? Back with high food inflation, if not high, general inflation.

Is there anything that can reverse the trend?

In the next one or two years, the answer is no. The only scenario in which inflation actually can fall is if the world goes into a recession again - which is not difficult to visualise.

The US cannot forever live on zero cost money, and the eurozone is reeling under one Greek tragedy after another. Japan is nowhere near normal, and China is trying to slow down to deal with inflation- exactly like us.

If the world slows, it is good for inflation. Remember, in 2008, it was the global recession that saved prices from going out of control. But when the world rebounded, inflation soared.

But, either way, we are going to be back to 7% growth rather than the 9% the UPA assumed was its birth right. No matter what it does, the economy will continue to drift around that level all the way to 2013-14.

TN Ninan of Business Standard argues that the UPA has a one year window of opportunity to get its act together, having already wasted the last two years in scams and non-governance. But then, the UPA has been deaf to good advice before, and briskly setting itself up for failure in 2014.

The UPA’s best suit- the Mahatma Gandhi Rural Employment Guarantee Act (NREGA, for short) - was the Congress’ best gift to the country, having lifted millions of people out of poverty. NREGA was one of the factors that helped the Congress win the last election.

However, it is a double-edged sword, and the UPA doesn’t know how to handle it. Since high food inflation has been partly the result of NREGA, the scheme is pushing back some people into poverty even as it pulls many out of it.

The World Bank estimates that between June and December 2010, over 10 million people were back in poverty due to inflation. This will spell danger for the UPA.

In 2010-11, the scheme created 256 crore man-days of work. Assuming 100 days of work were done by each person on an average under NREGA, this means 25 million people benefited from it during the year while 10 million slipped back into poverty. That’s two out of five. If the average is taken as 50 days of work, 50 million people benefited. So the ratio is one in five people falling back into poverty due to inflation.

The UPA is in a bind, and unless it gets its reforms moving, it will be faced with a double-disaster by 2014. Rising inflation, and people slipping back into poverty due to it. Merely throwing money at the problem works once - as it did in 2009 - but counting on a second round of luck is a bit much. Especially since we haven’t factored in even one bad monsoon over the next three years.