The price of inflation

The announcement that inflation has touched 11.05 per cent — the highest rate since 1995 — could not have come at a worse time for the United Progressive Alliance government. A political controversy is raging over the nuclear deal with the United States; the Congress-led minority government is at odds with the Left bloc that keeps it afloat; and the 15th general election is due in less than 10 months. One thing is clear. What voters will look for are the fundamental accomplishments and failings of the UPA — and here the issue of prices is bound to be at the top of the list of concerns. While the Prime Minister, as an economist, is right in calling attention to international factors beyond his government’s control (such as the rising price of basic materials like steel, cement, and oil), his government faces fierce political criticism for its slowness, verging on ineptitude, in responding to the unfolding crisis. Thanks to the recent hike in the price of oil products, the inflation rate is now in double digits. What is more, the cascading second-order impact of higher fuel costs on manufacturing has yet to be felt. Taming inflation, therefore, has to be the government’s overriding political economy priority.

Economic theory provides many tools for dealing with rapidly rising prices but the problem confronting the Finance Ministry and the Reserve Bank of India is how to attack inflation without undermining the economy’s growth rate or adversely affecting the poor. Tightening monetary policy will yield only limited success given the less-than-rosy state of the credit market and runs the risk of choking off growth. Similarly, any attempt to cut government expenditure in the hope of reining in inflation from the demand side is likely to prove disastrous, especially if the Finance Ministry goes after soft targets like the poor. Prime Minister Singh underlined the obvious when he noted recently: “inflation is an iniquitous tax… it hurts the poor more than the rich.” The point is that considerable damage has already been done. India lacks a social security net but the Public Distribution System and the ‘Right to Work’ envisaged by the National Rural Employment Guarantee Act offer the government at least two mechanisms for meaningful intervention on behalf of the poor. Far from cutting the ‘subsidies’ these programmes get as part of some misguided anti-inflationary policy, it must step up fiscal allocations and also adopt effective administrative measures to ensure there is no leakage. Unless the Manmohan Singh regime gets its act together quickly, there is every possibility of the UPA being punished by the electorate in much the same way the Bharatiya Janata Party-led National Democratic Alliance was in 2004.

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