Raining in inflation...
The arguement for reigning in inflation is a profound one. The current economics theories suggest that runaway inflation will eventually erode a nation's competitiveness with wage increases reaching ahead of productivity increases. In case of India its further complicated by our pretensions of a welfare state. Inflation hits the lowest, the most vulnerable section of the society the hardest. The question to ask however is, "Do knee jerk reactions like the monetary policy measures of central banks, duty reductions or export bans really help?"
My guess is NO...specially the export bans...taking a systemic view of the problem...inflation is unavoidable with a consumption led growth...the sort of growth that we are experiencing...and reveling in. Unlike the chinese experience, a country with substantially higher savings and investments we are driving growth through consumption - driven largely by a distorted services economy and retail credit.
This phase of spiralling inflation has two distinct characteristics - unabated asset inflation and supply side constraints. Its the chicken and egg dilemma...what came first...asset inflation or supply constraints...unfortunately what we are witnessing is even more complicated...increased supply somehow refuses to upset the asset prices juggernaut as the asset prices are increasingly driven by a new global phenomenon - mispricing of risk.
This global mispricing of risk is what manifests itself into cross border liquidity, capital flows of hitherto unknown amounts, dare-devil takeovers of Goliaths by new world David's and an acyclical asset price increase across all asset categories - equity, bullion, real estate, commodities...
My guess is that there are a few important historical developments playing out and one phrase sums them all up - The World is Flat!!!
Communication, Technology, Globalization, integrated and sophisticated financial markets, accumulated expertise of private sector, a mature geo-political environment (terrorism and the odd military coup is par for the course now) - all these have led to an environment where all investment decisions are increasingly becoming financial decisions alone - the operational, legal and maket related issues can now be handled with near certainity. This is efficient markets at their best - all assets have a price - better still all assets almost guarantee liquidity. As business cycles become compressed and the policy reactions become more and more concerted the chances of an all round global hard landing have become remote. The evidence from the slowdown and recovery after 9/11 also suggests that a truly global world economy has far more depth and breadth today than ever to counter any disruption or cyclical downturn. All these factors combined significantly lower the risk of investors and hence repricing of assets is underway.
However asset inflation also drives up inflation in other sectors of the economy and thus potentially leads to 'runaway' inflation. No responsible government today can let inflation balloon as it hurts the real value of the nation's currency and its assets, investors may lose confidence, industry might find building capacities impossible, earnings on bonds and debt can turn negative and hence the savings in the economy may evaporate...All in all its a very very precarious situation for a growing economy to be in.
Higher interest rates for corporates and moderate interest rates for housing and allied sectors again is not an ideal solution. Investments by corporates should ideally be in productive assets and technology upgrades, exactly the sort of things that improve the supply side, increase efficiency and reduce pressure on constrained resources including labor. On the other hand pure asset inflation driven by speculation and non productive investment does little to improve supply, increase efficiencies or improve distribution of productive assets.
Some people argue and I agree, that stymying growth in the pretext of curtailing inflation is really not the solution especially for growing economies like ours. In the context of mature economies like the US or UK it may be feasible to work out a sustainable growth rate as their resource utilization, both natural and human is nearly 100% and factor productivity will be amongst the highest in the world. A phase of accelerated growth is thus likely to be followed by a slowdown - and if moderated responsibly enough by governments and central banks its unlikely to cause any major economic or social distress with various social security measures in place.
However for a growing economy like ours where a vast majority subsists at the peripheries of economic growth living mostly off urban effluents and a meagre rural output this strategy can stunt our overall economic potential. As a country we need to invest to make this growth structural rather than cyclical as we can not afford a cyclical downturn for years to come. The challenge is how to do that and the answer is also fairly fundamental. We can not overturn the logic of monetary economics but we can indeed look at areas where we are yet to catch up with the mature economies which form the basis of its models. These areas are essentially to augment the supply side and increase efficiency to make demand superfluous rather than constrict the demand forcibly. By focussing on such means that can delay the consumption by introducing another important step - investments - we can do a lot to make our growth story structural and sustainable.
By investing in technology to improve factor productivity and efficiency we can improve our total asset productivity as well and thus reduce demand for scarce assets. By curtailing budgetary deficit, reducing the size of the government, disinvestments and reducing non plan and revenue expenditures we can reduce money supply in the market without affecting interest rates through blunt measures like CRR and SLR. Even the capital expenditure by government if efficiently and scrupulously employed in infrastructure and technology upgradation will go a long way in breaking the cycle of immediate consumption and build supply side capacities to meet higher future demand without inflationary pressures. Unfortunately the government so far is pushing the wrong buttons - increasing subsidies, reducing duties, banning exports- just the sort of thing that preempts investment into capacity augmentation and efficiency improvements. Its time our governments bit the bullet and did the right thing however tough it may be. India today is at a cusp; a structural shift in its development needs more than just passive approval by the government. What we need is a massive revamp of the government sector; just as the private sector has responded to the so-called threat of liberalization and come out trumps, the government sector too needs reform, competitiveness and efficiency...time is running away...so is inflation.
My guess is NO...specially the export bans...taking a systemic view of the problem...inflation is unavoidable with a consumption led growth...the sort of growth that we are experiencing...and reveling in. Unlike the chinese experience, a country with substantially higher savings and investments we are driving growth through consumption - driven largely by a distorted services economy and retail credit.
This phase of spiralling inflation has two distinct characteristics - unabated asset inflation and supply side constraints. Its the chicken and egg dilemma...what came first...asset inflation or supply constraints...unfortunately what we are witnessing is even more complicated...increased supply somehow refuses to upset the asset prices juggernaut as the asset prices are increasingly driven by a new global phenomenon - mispricing of risk.
This global mispricing of risk is what manifests itself into cross border liquidity, capital flows of hitherto unknown amounts, dare-devil takeovers of Goliaths by new world David's and an acyclical asset price increase across all asset categories - equity, bullion, real estate, commodities...
My guess is that there are a few important historical developments playing out and one phrase sums them all up - The World is Flat!!!
Communication, Technology, Globalization, integrated and sophisticated financial markets, accumulated expertise of private sector, a mature geo-political environment (terrorism and the odd military coup is par for the course now) - all these have led to an environment where all investment decisions are increasingly becoming financial decisions alone - the operational, legal and maket related issues can now be handled with near certainity. This is efficient markets at their best - all assets have a price - better still all assets almost guarantee liquidity. As business cycles become compressed and the policy reactions become more and more concerted the chances of an all round global hard landing have become remote. The evidence from the slowdown and recovery after 9/11 also suggests that a truly global world economy has far more depth and breadth today than ever to counter any disruption or cyclical downturn. All these factors combined significantly lower the risk of investors and hence repricing of assets is underway.
However asset inflation also drives up inflation in other sectors of the economy and thus potentially leads to 'runaway' inflation. No responsible government today can let inflation balloon as it hurts the real value of the nation's currency and its assets, investors may lose confidence, industry might find building capacities impossible, earnings on bonds and debt can turn negative and hence the savings in the economy may evaporate...All in all its a very very precarious situation for a growing economy to be in.
Higher interest rates for corporates and moderate interest rates for housing and allied sectors again is not an ideal solution. Investments by corporates should ideally be in productive assets and technology upgrades, exactly the sort of things that improve the supply side, increase efficiency and reduce pressure on constrained resources including labor. On the other hand pure asset inflation driven by speculation and non productive investment does little to improve supply, increase efficiencies or improve distribution of productive assets.
Some people argue and I agree, that stymying growth in the pretext of curtailing inflation is really not the solution especially for growing economies like ours. In the context of mature economies like the US or UK it may be feasible to work out a sustainable growth rate as their resource utilization, both natural and human is nearly 100% and factor productivity will be amongst the highest in the world. A phase of accelerated growth is thus likely to be followed by a slowdown - and if moderated responsibly enough by governments and central banks its unlikely to cause any major economic or social distress with various social security measures in place.
However for a growing economy like ours where a vast majority subsists at the peripheries of economic growth living mostly off urban effluents and a meagre rural output this strategy can stunt our overall economic potential. As a country we need to invest to make this growth structural rather than cyclical as we can not afford a cyclical downturn for years to come. The challenge is how to do that and the answer is also fairly fundamental. We can not overturn the logic of monetary economics but we can indeed look at areas where we are yet to catch up with the mature economies which form the basis of its models. These areas are essentially to augment the supply side and increase efficiency to make demand superfluous rather than constrict the demand forcibly. By focussing on such means that can delay the consumption by introducing another important step - investments - we can do a lot to make our growth story structural and sustainable.
By investing in technology to improve factor productivity and efficiency we can improve our total asset productivity as well and thus reduce demand for scarce assets. By curtailing budgetary deficit, reducing the size of the government, disinvestments and reducing non plan and revenue expenditures we can reduce money supply in the market without affecting interest rates through blunt measures like CRR and SLR. Even the capital expenditure by government if efficiently and scrupulously employed in infrastructure and technology upgradation will go a long way in breaking the cycle of immediate consumption and build supply side capacities to meet higher future demand without inflationary pressures. Unfortunately the government so far is pushing the wrong buttons - increasing subsidies, reducing duties, banning exports- just the sort of thing that preempts investment into capacity augmentation and efficiency improvements. Its time our governments bit the bullet and did the right thing however tough it may be. India today is at a cusp; a structural shift in its development needs more than just passive approval by the government. What we need is a massive revamp of the government sector; just as the private sector has responded to the so-called threat of liberalization and come out trumps, the government sector too needs reform, competitiveness and efficiency...time is running away...so is inflation.
posted by Prashant at 1:29 AM
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