The government’s claim that it will dampen inflation, bring higher prices for farmers and lower prices for customers may be somewhat exaggerated
With the intention of signalling a strong commitment to reforms, the UPA government has announced a hike in the price of diesel and liberalisation of foreign direct investment (FDI) in multi-brand retail, justifying the measures as growth-enhancing and inflation-dampening. They have been termed bold by India’s corporate sector and burdensome by an Opposition united across the ideological spectrum. In his speech to the nation on September 20, the Prime Minister stated that the government’s move is motivated by concern for the ordinary Indian. Given the conflicting responses, there is room here for analysis.
The interesting thing about public sector pricing, in this case of diesel, is that keeping prices steady as input costs rise would be as political in content as raising them is. As stated in an editorial in this newspaper some days ago, the government need not have waited so long to raise the price. It would seem that the government had no intention of doing so while Parliament was in session. Be that as it may, there is a strong case for eliminating the subsidy on all fossil fuels and transferring the saving thus made into public infrastructure. Apart from the symbolism of soaking the SUV-driving rich, the building and maintenance of public infrastructure are more likely to help the poor — presumably the PM’s aam aadmi — than the current regime of subsidies.
The creation of infrastructure employs the poor directly as it is they who build it. Secondly, the provision of the producer services afforded by the infrastructure sustains private economic activity which generates employment. The idea that the poor would benefit more from public investment than the present subsidy regime, described by some as welfare state for the rich, has not really been sufficiently debated. For India’s political class, subsidies are the easiest path to being seen as benefactors while being relieved of the task of managing the process of building and maintaining infrastructure, arguably a non-negotiable aspect of governance in a democracy. So, even a small hike in the price of diesel can be the beginning of a realignment of government expenditure from consumption subsidies to investment in infrastructure, and the poor may be expected to gain from this. Finally, the gains from macroeconomic stability cannot be legitimately ignored when evaluating the prospects for the poor. Macroeconomic instability spares nobody, and India’s current account deficit by now exceeds the figure for 1991. Fuel subsidies have enormous consequences for the balance of payments, as 80 per cent of our oil consumption is imported.
When it comes to FDI in retail, the beneficial impact on the aam aadmi is altogether less obvious than in the case of lowering the diesel subsidy. What FDI in this sector may be expected to do is to take the shopping experience in India to the next level. Surely, cavernous supermarkets make it easier to shop for those with deeper pockets. Precisely because the supplier caters to this cohort the quality of the groceries may be expected to rise. In fact, we have already seen this happening, even without FDI, with organised retail spreading in India. But those on a daily wage and no ready cash are unlikely to patronise these suburban behemoths. They may be expected to prop up the kirana with its infinite capacity for apportioning their stuff to suit the customer’s purse and willingness to extend her credit. So the Opposition may well be crying wolf over the imminent disappearance of the corner store.
But the government’s claim of a ‘win-win’ with higher prices for farmers and lower prices for customers with the advent of FDI may be somewhat exaggerated. For precisely because the large retailer must cut through the supply chain to deliver this outcome, there would be some displacement in the middle. The government counters this reasoning by pointing to investment at the backend, in cold storage and such. This is possible of course, but we would want to wait and see the full combined effect once all effects have worked their way through the economy. Some part of the corner-store complex will survive purely because there are too many poor people in this country yet, generating a substantial demand for low quality food with lower mark-ups. But the position that a policy is only as good as its direct impact on employment is surely untenable. To reject outright a move on the grounds that it does not directly put the poor to work would be folly. Productivity growth is often first employment displacing but it also lowers prices and raises demand. The point is that it not only raises demand for the good in question but for all other goods in the economy, as real income is higher following the rise in productivity. Overall employment in the economy may be expected to expand.
Little to offer
It is when it comes to inflation though that the present round of announcements by the government has little or nothing to offer. The suggestion, first made when the proposal was mooted some months ago, that FDI in retail would dampen inflation is difficult to fathom. The source of the current inflation is a veritable excess demand for vegetables and a manufactured excess demand for the principal foodgrains. The latter stems from the government’s procurement and storage policy. By mopping up almost the entire marketed surplus of grain as it comes into the wholesale markets and then allowing it to rot by unaccountable stock management, the Government of India abets hunger in the name of supporting the farmer. The entire political class is united in not calling attention to this travesty.
The RBI’s argument that the fiscal deficit is the source of the inflation may deflect attention from its own incapacity in the present context, but does not do much to enhance our understanding of policy options. The Central government’s fiscal deficit is lower today than it was when the present bout of inflation commenced about two years ago. Thus the hike in the price of diesel would have to be justified on counts other than its presumed impact on inflation via a lower fiscal deficit. The current inflation is rooted less in macroeconomic imbalances than in structural ones emanating, as explained above, in the market for food. As a corollary, macroeconomic intervention via fiscal or monetary policy can have only a limited impact. As an aside, they can only compress output, a sequence of events playing out in the guise of a slowing manufacturing sector. It is by now clear that only microeconomic policy intervention can make a difference to the food situation and thus inflation. In India the cost of producing food is high in relation to per capita income. FDI in retail can make no difference here. It can at best only deliver more efficiently what has been produced at cost. The government can hardly be accused of not knowing of the importance of micro interventions.
For instance, it has been observed that vast sums of money spent by the government on irrigation were not showing up as increase in irrigated area. This was at least five years ago. Now there are reports of an irrigation scam involving Rs 20, 000 crore in Maharashtra, a State for all purposes governed by the UPA. It is quite extraordinary that the current food-price led inflation has been in existence for over two years now and the government has not been able to come up with a single measure addressing it, even if its impact may be felt only in the medium term. When it is not actually stoking inflation by raising the procurement price of grain it comes up with window dressing in the form of FDI in retail.
It would be appropriate to conclude by asking whether the government makes too much of foreign investment, desirable as it is. With respect to its heroic recent announcement, there is the issue of the suppliers’ response. Walmart’s Asia President Scott Price is reported to have already stated “we are not in any rush” to enter India. But there is a query more general than the likely response of foreign investors to the overtures being made presently. In the two decades since 1991, India has not attracted much FDI, giving us an idea of what may be expected in a future with or without FDI in retail. Some perspective is to be had from looking at the Chinese experience. For an idea of the relative roles of FDI and domestic investment in generating growth in that country, note that FDI as a share on the domestic product had peaked in 1993. It was only 6 per cent even then, and has declined progressively since to a figure less than half that. This suggests that China’s double-digit growth cannot be explained by alluding to the FDI it attracts. Is our own government overrating the power of foreign investment to transform India’s economy?
(The author is on the faculty of Economics at the Centre for Development Studies, Thiruvananthapuram. He may be reached at www.pulaprebalakrishnan.in)