Early December brought good and bad news on the economy. The good news was the evidence from the Central Statistical Organisation of a better-than-expected recovery in the second quarter (July-September) of 2009-10. GDP growth that quarter is placed at 7.9 per cent relative to the corresponding quarter of the previous year. This was not only way beyond growth rates in the previous three quarters when they averaged between 5.8 and 6.1 per cent, but even marginally above the growth rates in the first two quarters of 2008-09 when the effects of the global recession were just beginning to be felt. This sharp recovery has triggered official speculation of a quick return to the 9 per cent growth trajectory of the five years preceding the slowdown in growth.
The bad news of course is that food prices still continue to climb. During the week-ended 21 November 2009, the Wholesale Price Index for Food Articles had registered a point-to-point annual rate of increase of 17.47 per cent. This compares with the 10.75 per cent rate of food price inflation recorded in the comparable week of the previous year, which too was uncomfortably high. Since prices in retail markets would have risen by much more than the WPI, the problem needs urgent attention.
The combination of creditable GDP growth and high inflation has triggered debate on whether it is time for the government to exit from the stimulus it put in place when the globally-induced deceleration set in. This debate is in part misplaced. A considerable part of the so-called “stimulus” was not engineered but fortuitous. With the government having had to set up a Pay Commission for its employees and implement its rather generous recommendations, which involved paying a large amount as arrears, a substantial increase in expenditures was inevitable. What has happened is that something that would have otherwise been considered a “burden” that threatened fiscal stability was in the wake of the crisis presented as a necessary increase in expenditure in response to the downturn. If we exclude this unavoidable expenditure, especially the payment of a large amount as arrears for the period from January 2006, the size of the stimulus adopted specifically in response to the crisis collapses.
The government, however, treats all the increases in its expenditure as being a consciously adopted stimulus. If defined thus, a reduction in the stimulus during the next fiscal is unavoidable, since the arrears would be paid out only once. If in addition the government chooses to reduce or even keep constant the stimulus launched in response to the downturn in the form of new expenditures other than its wage and salary bill, a significant decline in aggregate expenditure that had a countercyclical influence is the obvious consequence. The question, therefore, is whether this would leave the recovery untouched without affecting inflation.
An interesting feature of the recovery in GDP growth in the second quarter of 2009-10 is that, when analysed from the expenditure side, much of it has been on account of an increase in the government’s Final Consumption Expenditure. This component in the national accounts is the one which captures the effects of the implementation of the VIth Pay Commission’s recommendation. Its importance can be gauged from the following: The sum total of Private Final Consumption Expenditure, Gross Fixed Capital Formation and Exports which grew at 10.02 and 8.76 per cent respectively during the first and second quarters of 2008-09, registered changes of minus 0.51 per cent and a meagre 2.44 per cent in the first and second quarters of 2009-10. On the other hand Government Final Consumption Expenditure which registered changes of 0.19 and 2.19 per cent respectively in the first and second quarters of 2008-09, grew at a remarkable 10.24 and 26.91 per cent in the first and second quarters of 2009-10. Thus the recovery was largely the result of an increase in Government Consumption Expenditure, which would fall both because of the absence of the windfall Pay Commission arrears payments in the next fiscal and because of any reduction in the government’s stimulus.
Thus, the evidence indicates that, everything else remaining the same, if the government does not increase its aggregate expenditures in the next fiscal, we could experience another downturn. India too seems set for a “double-dip” recession, especially because the expenditure under the arrears head would not be undertaken and needs to be substituted with some other set of outlays. In the circumstances, thinking of dealing with inflation by exiting from the fiscal stimulus may not be altogether a good idea.
What is more there are reasons to believe that an exit from the stimulus may not be the best way to deal with inflation given it features. To start with, the inflation in food prices has been with us for some time now, despite the growth slowdown. That is, it has been underway despite a contraction in overall demand. Second, while food price inflation has accelerated after it became clear that rainfall in much of the country during the southwest monsoon was well below its long term average, the inflationary process began before the failed monsoon. Third, the inflation occurs despite the fact that foodgrain stocks with the government are comfortable, and well above the buffer stocking requirement. Finally, inflation has occurred even though the country’s foreign exchange reserves are comfortable, giving the government the option of importing food to augment domestic supplies and rein in prices.
Given all this, the unavoidable conclusion is that food price inflation is in substantial measure the result of speculation. What is called for then is not an exit from the fiscal stimulus with adverse consequences for growth, but direct measures to deal with speculators and dishoard their stocks, while augmenting availability through a strengthened public distribution system. This is likely to be more effective and less damaging for the economy.
Keywords: economy, Central Statistical Organisation, recovery, GDP growth, food prices, Wholesale Price Index for Food Articles, WPI, stimulus, Pay Commission, Final Consumption Expenditure, Private Final Consumption Expenditure, Gross Fixed Capital Formation and Exports, inflation