Gargantuan spending without addressing underlying supply bottlenecks
Inflation is like fever — it is not the disease itself but a symptom of an underlying disease. The right approach is to treat the underlying disease and not focus on treating the symptoms.
Supply bottlenecks are the underlying problem
Inflation is the direct result of the UPA government’s failure to put in place the necessary policies that could sustain the growth spurt that started during the NDA’s term. When an economy grows at 8% year on year all classes of people — poor, middle-class, rural and urban — will demand more goods & services. Yet, the UPA government has failed to ensure that the economy can produce and efficiently distribute goods & services. This is the core cause of inflation.
The anaemic growth in infrastructure industries is an indicator of the policy failures that have led to inflation. Better infrastructure can moderate price rises by better connecting buyers and sellers. Despite the economy growing at 8%, the infrastructure industries growth has been only 6.7% under the UPA government. In fact this has further fallen to 5% in mid-2010. The shortfall in power supply has worsened from 8.5% in 1992 to 12% in 2008-09. Worse, capacity addition in thermal power is a mere 4.4% of the target.
NREGA has contributed to price rises in many areas because the UPA government has failed to make rural markets competitive. In a village with a few shops, any rise in income of the villagers will cause shopkeepers to increase their prices. If rural areas are better connected to each other with good roads, electricity and cheap transport, villagers can purchase goods in adjacent villages if the goods are cheaper there. Despite the claims by the promoters of NREGA it is unclear if NREGA has benefited the rural poor. The UPA government has shown much less enthusiasm to complete the Golden Quadrilateral programme and extend it to rural areas.
The UPA government has failed to enable farmers to participate in India’s growth. The failure to dismantle barriers to agricultural marketing and failure to integrate India into a single market for agricultural goods not only contribute to food price inflation but undermine the welfare of farmers. (Farmers receive only 50 paisa for a kilo of tomatoes while consumers pay Rs 20).
It is a matter of basic economics that when demand rises faster than supply, prices will rise. By neglecting this basic reality, the UPA government has created the conditions for inflation
Regarding fuel prices
The UPA frittered away the chance to complete the process of fiscal consolidation started by the NDA government, otherwise credit rating agencies like Moody’s would have upgraded India’s sovereign credit rating a long time ago, rather than in 2010.
The removal of fuel price subsidies was done without adequately preparing the nation for the same. The UPA has not revealed that it intends to rectify the fundamental problems in the petroleum sector because of the patchwork of pricing policies. Furthermore, despite it being clear for the last few years that energy prices are rising globally, the UPA government failed to create the framework for a massive improvement in public transportation.
The removal of petrol subsidy and rise in prices does not directly affect the poor — mostly they use buses and trains. Those who use two-wheelers are affected. However, despite presiding over a healthy economy for over 8 years, there is no sign of the UPA government evolving a integrated public transport policy. Instead there is a continuation of the licence-permit raj that leads to the harassment of auto-rickshaws and other private bus operators, and increasing inconvenience for ordinary people.
The fuel pricing policy has damaged our public sector and private sector oil & gas companies. Reliance had to close down 2000 petrol stations because prices are non-remunerative — this is a major waste of capital. While the UPA government is damaging our oil & gas companies in this way, the Chinese government is throwing its weight behind their state-owned companies to corner energy resources around the globe.
UPA’s fascination with pet projects is diverting attention from the necessary ones. For instance, instead of thinking of only building a pipeline to buy natural gas from Iran, and paying money to the Pakistani government to safeguard our lifeline, we should have invested in building LNG terminal & pipelines along our coastline. Investing in ports, refineries and pipelines in India would not only increase the income of Indians but also improve our energy security. We can still buy the gas from Iran without having to depend on Pakistan.
(This note was prepared and privately circulated in July 2010. It is published here as it is still relevant, unfortunately.)