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ECONOMY-INDIA: Inflation Spiral Mars High Growth Rates

Analysis by Paranjoy Guha Thakurta

NEW DELHI, Mar 2 2007 (IPS) - Although India’s economy has been growing at an impressive clip of nine percent a year, the federal government is under fire from the opposition as well as its allies for failing to control inflation.

A sharp spurt in food prices in recent months has translated into popular resentment. On Wednesday, the Congress party, which heads the ruling centre-left United Progressive Alliance (UPA) coalition government in New Delhi, lost provincial elections to two important northern states where it was in power – Himachal Pradesh and the farming Punjab.

The federal budget for the financial year starting Apr. 1, presented by Finance Minister Palaniappan Chidambaram on Wednesday, reduced customs and excise duties in the hope of dousing inflationary fires. And Prime Minister Manmohan Singh has emphasised that curbing the rise in prices of essential food products would be high government priority.

However, critics argue that measures taken were too few and too late to prevent ‘overheating’ in the economy. These include increasing the cash reserves of banks to reduce money supply and hardening interest rates. A ban on forward trading in wheat was imposed on Tuesday and export of various food products stopped to increase domestic supplies.

Though inflation has never touched triple-digit levels as it did in certain Latin American countries, by Indian standards the rise in prices has been steep. The official wholesale price index went up by nearly 7 percent in early February before coming down marginally. Consumer price indices are roughly two percentage points higher.

Till August, inflation in India was driven mainly by higher prices of petroleum products. Since then, articles of mass consumption such as wheat, onions, milk, fruits and vegetables have risen due to demand pressures. Imports have helped redress the imbalances between demand and supply only to an extent.

Since food comprises a larger portion of the incomes of the poor, the rise in inflation has adversely affected economically weaker sections. Close to a third of India’s population, or over 300 million people, live below the internationally-accepted poverty line of one US dollar a day and two-thirds earn daily incomes of two dollars or less a day.

Rakesh Mohan, deputy governor, Reserve Bank of India (the country’s central bank and apex monetary authority), described inflation as a “tax on the poor against which no hedges are available.”

Harvard-educated Chidambaram has a reputation for supporting market-friendly, neo-liberal economic policies. But his budget has a populist flavour aimed at ensuring that the Communist parties, which provide crucial outside support to the government, are happy.

The budget has increased financial outlays on agriculture, rural development, irrigation, education, health care and road construction. At the same time, Chidambaram has proposed higher taxes on the corporate sector. Consequently, stock-market indices came crashing down. Generous tax breaks that were given to information technology companies – that showcase the proficiency of Indian professionals in computer software and business process outsourcing – have been removed.

“The budget signifies a phase of consolidation for an economy that has grown at an unprecedented pace that has created in its wake, inflationary pressures and infrastructure bottlenecks,” says Saumitra Chaudhuri, member of the Prime Minister’s economic advisory council. He told IPS in an interview that the biggest challenge before the country was to increase agricultural production and farm productivity.

One out of three Indians cannot read and write his own name and half the children who join primary school drop out. Chidambaram has announced new scholarships that give incentives to secondary school students to continue studying. Schemes to provide mid-day meals for school-going children have been enlarged.

Significantly, there has been an across-the-board increase in a levy on all taxes to fund education. The levy will support an affirmative action plan to increase seats in educational institutions to admit more students from “socially and educationally backward classes.”

India’s industrial sector has grown by nearly 10 percent a year over the last three years while the services sector has expanded by over 10 percent per annum in this period. And a high 9 percent per annum growth rate has been sustained for two successive years.

The problem area is agriculture which accounts for less than one-fifth of India’s gross domestic product (GDP) but directly provides livelihoods to 60 percent of the country’s population. The farm sector in India has grown by only two per cent per year or less over the last decade and a half.

In the budget for 2007-2008, the UPA government has sought to counter criticism that its policies were primarily aimed at helping businesses grow. A pro-farmer tilt is now apparent. It has been proposed that more crop loans be provided, production of seeds be increased and water bodies be renovated.

Ambitious targets for providing housing, electricity and phones in villages have been set. The coverage of a rural employment guarantee scheme – described as the world’s largest legally mandated social security programme – has been expanded from roughly one-third of the country’s geographical area to more than half.

Chidambaram intends spending more on social welfare programmes while reducing budgetary deficits because tax revenues have been buoyant. Barring excise collections that have grown slowly, customs duties, personal income taxes and taxes on corporate incomes have all gone up above expectations. The services tax net has been widened to include, among other services, rent from commercial properties and asset management services.

India’s exports have been growing at a rapid pace of 20 percent a year – foreign trade is growing twice as fast as its GDP. Chidambaram has reduced peak customs tariffs on non-agricultural imports from 12.5 percent to 10 percent, bringing these rates closer to levels prevailing in East Asia. This is seen as an anti-inflationary measure.

“Ten years ago, Chidambaram (who was then not in the Congress party and was serving as finance minister in another left-leaning coalition government) presented what was described by the media as a ‘dream’ budget; this budget is grounded in reality,” Shankar Raghuraman, editor, research, in the ‘Times of India’, the largest circulated English daily in India and the world, told IPS.

Budgets in India tend to be much more than mere statements of financial accounts. The UPA government headed by Singh – called the architect of economic liberalisation after he relaxed bureaucratic controls in 1991 when he was finance minister – has had to accept the compulsions that go with running a coalition government that relies on support from four Left parties for its survival in power.