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Globalization and Inflation In recent years, a sizeable section of the Indian intelligentsia has come to embrace globalization as a veritable bonanza. India's young graduates have been finding jobs with relative ease, and salary increases have been greater than most could have anticipated. Indian businesses have seen buoyant revenues and handsome profits. And the most ambitious of Indian corporates have been expanding overseas at a pace that has left even their detractors somewhat amazed. As a result, earlier critics of unfettered globalization have been made virtually irrelevant. Many young Indians have come to believe that a new India just around the horizon - that India is on the cusp of modernity and prosperity. They have entrusted their faith to the purported virtues of globalized "free markets" and the apparent "efficiences" of private corporations - whether Indian or multi-national. While there is no doubt that English-speaking educated Indians have been in demand throughout the world, the situation for the vernacular Indians has not been quite as favorable. This has naturally led to an unresolved tension that has manifested itself in various (seemingly unrelated) forms. In some cases, it has spawned justifiable political movements for greater equity and redress of past wrongs or recent neglect. But more frequently, it has led to more regressive expressions of religious sectarianism (as in Kashmir) or chauvinist regional or even sub-regional ultra-nationalism (as in Maharashtra). In other instances, the government (in trying to cover-up its own failures to deliver on essential social services) has incited unhealthy caste or religion based sectarianism by resorting to the old gimmick of ever-expanding quotas and other political sops. Many of these political ploys have had negative hidden (or even, not so hidden) economic or sociological costs, but most political pundits have chosen to ignore such political recklessness. Few Indians have connected the dots and seen the connections between economic policy and the many social conflagrations that appear to break out at random, and with annoying regularity. Nor have they put their mind to fair and equitable resolutions to such discontent or disruption. In a rising economy, populist concessions sometimes do the trick, and time and again (as with the last budget), the government has tried to take the easy way out. But recently, talk of an extended US recession and the unrelenting rise in commodity prices has given some pause to the earlier euphoria that had gripped the upwardly-mobile sections of urban India. A 36% decline in the stock market has been a further dampener - indicating to the intelligent few that as nations go in and out of favor in a global economy, stock markets display increased volatility, and they can fall just as fast as they rise. But perhaps, far more troubling for India's ruling coalition has been India's out-of-control inflation. In spite of two years of very aggressive fiscal tightening, Indian inflation has begun to behave like a wild foal, refusing to be reined in. Since October 2007 (contrary to repeated government claims) every round of rate increases has led to a faster rise in inflation, not a decrease. Could it be possible that the nation's Manmohan-Chidambaram economic "dream team" may not be quite as competent as generally believed? That overly aggressive import/export liberalization and privatization of vital mineral resources and essential services might lead to runaway inflation in a nation that is as densely-populated as India? For instance, each time Chidambaram has assumed charge of the finance ministry, he has moved to radically cut import and export duties - not selectively (so as to assist vital domestic industries or to make Indian industries more viable and competitive), but across the board. Complaints of potential dumping, of non-level playing fields, or the potential of excessive foreign dependance - have all fallen on deaf ears. Domestic manufacturers who have expressed concern about potential shortages of vital raw materials and key industrial inpits have likewised been ignored. Critics who cautioned that the lost revenue from falling customs duties might lead to a decrease in plan expenditure on power and other essential infrastructure were also summarily dismissed. But the reality is there for all to see. Nation-wide, power shortages ahve not decreased. Manufacturers and traders have simply compensated for the lack of power by increasing their reliance on generators powered by expensive imported fuel. City dwellers dissatisfied with public transport options bought more cars and larger cars. As long as global inflation was low, such liberalization did not appear to hurt much. But today, such liberalism has come at a heavy price. Thanks to the US military intervention in Iraq, world oil supply has been choked and speculators and price-fixers have collaborated to take full advantage of the rising demand for oil. (What is worse is that even some of the oil that is pumped out of Indian soil (as in Rajasthan by Cairns Energy) is costing India 20 times its actual production cost.) At the same time, unrestricted imports of high-priced luxuries has escalated, and more and more industries have become dependant on what once seemed cheaper imported industrial inputs. Not only has India's oil-import bill sky-rocketed, India's overall trade balance has been showing very troubling trends. In particular, its trade balance with China has become especially skewed. With a falling Rupee, a rising Yuan and galloping transportation costs, Indian industries are now paying a lot more for their Chinese imports, which is putting further pressure on wholesale prices. But high interest rates are now preventing domestic manufacturers from setting up new plants to fill the gaps and compensate for the more expensive imports. Two years ago, industry associations like ASSOCHAM and even FICCI had warned that the high interest rate regime would hurt small and medium manufacturers, but such warnings fell on deaf ears. Steal manufacturers like the Tatas had cautioned against run-away exports of iron ore and they too were ignored. Today, steel prices have jumped - further adding to the woes of domestic industry. BHEL had been warning that Chinese power equipment typically operates at 65% efficiency as compared to the 90%+ efficiency of its own products. Even though some of the first Chinese-supplied boliers developed cracks soon after installation, contracts were liberally awarded to private power companies relying on Chinese imports without regard to future running costs or reliability. Even as the government failed to heed the warnings from different sections of Indian industry, its excessively hawkish approach to fiscal management compounded the problem. For instance, throughout the world, interest rates are geared towards maintaining a certain level of the consumer price index. While it is expected that developed nations will have a low toleration for inflation, developing countries must also pay particular attention to the needs of industrial and economic growth. But instead, the Indian government tried to behave as though it was managing an already developed economy and set very aggressive targets for inflation control. And over and above those aggressive targets, it used the wholesale price index as its trigger for monetary tightening. Typically, wholesale prices are not passed on to consumers until there is a substantial reduction in profit margins. In 2006, most Indian industries were operating at very healthy margins, so there was little need for the government to base its fiscal policies on wholesale prices at that time. It should have allowed rising wholesale prices to send a signal to end-user manufacturers to adjust their sourcing policies and to look at other alternatives to maintain their margins. Rising wholesale prices could have also triggered increased domestic production of key commodities wherever possible. But the government refused to wait, and began tightening in 2006. This had two unhealthy side effects. It increased the costs for India's small producers, ancillaries and medium-scale industries which only fuelled the wholesale price index further. In extreme cases, marginal producers were simply squeezed out of the business altogether leaving India entirely on the mercy of imports (typically from China). On the other hand, the lower-middle class was prevented from making purchases (due to high consumer loan rates) even though adequate capacity existed (such as in the two-wheeler industry). However, multinationals and large Indian manufacturers weren't too bothered as they had recourse to the international markets for raising resources. While they were patting the government on the back for its fiscal management, the most vulnerable sections of Indian industry were finding themselves more and more impotent in influencing policy. And while India's lower-end consumers were being frustrated by rising loan rates, India's rich (with more than ample funds of their own) had no reason to cut back on comsumption even as rates rose. This further distorted India's consimption patterns. The lower middle class which typically bought goods that were locally produced was being denied market access through high consimer loans. But the rich were turning more and more to expensive imports. Globalization (and the government's response to it) has thus created a peculiar trap for India. India's service exports aren't growing as fast, but its domestic production and consumption patterns have fallen prey to external factors that are leading to spiralling wholesale price inflation. Many of the oft-touted gains of liberalization have failed to materialize. With the US economy in a recesion, export-oriented industries (that might have benefited from a liberal import regime) have failed to gain any significant advantage. Instead, domestic industry's dependance on Chinese imports has grown rapidly, without Indian exports to China growing in proportion. In a globalized economy, China has certain natural advantages over India. On a per-capita basis, it has much more land, industrial mineral wealth and energy resources. It is therefore less dependant on external commodity imports for its domestic consumption. This allows its industries to increase production more easily to take advantage of any openings in the international economy without hurting domestically-oriented manufacturing. At the same time, its domestic market is a highly protected one, and even where Indian industries are far more competitive (such as in two-wheelers, or other goods that are more energy-efficient or last longer) India has been unable to make any major inroads in the Chinese market. With the backing of their government, Chinese businesses have been extremely adroit in expanding market share in periods of rising global prosperity. But they have never had to compete on an equal footing with foreign competitors because the Chinese government has cleverly maintained protectionist policies even while it has attempted to take advantage of the possibilities offered by greater globalization. When positioned next to an anarchically managed resource-scarce economy (such as India) it can grow faster in times of prosperity even as it suffers less in times of economic distress. (This is not to say that the Chinese model is not without its grave flaws. At present only a fraction of China's manufacturing surplus has trickled down to the masses - since much of it has remained parked in low-yield US treasuries.) But be that as it may, it must be acknowledged that Indian industry finds itself increasingly squeezed between high international commodity prices and Chinese dumping and protectionism. Moreover, India's service exporters are finding it increasingly difficult to expand in the European and Japanese markets. These are highly conservative markets where India enjoys no particular linguistic or cultural advantage. Under such circumstances, it ought to be evident to most Indians that the Sonia-appointed Manmohan/Chidambaram/KamalNath team has steered India into what appears to be an economic trap. The so-called "dream team" have embraced globalization, but without fully comprehending its attendant impediments, risks and liabilities. The most apparent and immediate fall-out of this has been the government's increasing inability to effectively tackle the issue of inflation, for it can be argued that in the present circumstances, the government's own policies have greatly exacerbated the problem. While there is no doubt that external factors have much to do with India's present predicament, it needs to be underlined that inept government solutions (or even the traditional bookish remedies) may end up ensnaring the Indian economy into an inflationary spiral that might elude any quick or easy fixes. Take the manner in which the government decided to deal with the fuel price issue. It chose to pass on the greatest burden to the broad masses by mandating a 30% increase in LPG prices - adversely affecting the budget of virtually every urban Indian. Since cooking is not an avoidable activity, it would naturally have no effect on mass consumption patterns. A more effective measure would have been to tax avoidable energy use to redirect consumer behaviour towards energy savings and/or alternative energy use. The government could have instead raised taxes on energy-inefficient environmentally unfriendly products (like kerosene or petrol-based generators and pumps). It could have introduced an additional tax on all existing fuel-inefficient luxury vehicles (not just new vehicles). Or it could have taxed the conspicuous consumption of the rich - especialy during activities involving profligate energy use. Additionally, it could have (and some might well argue that it should have) taxed the windfall profits of companies like Cairns Energy. Instead, it chose to pass on the problem to the masses in a manner that was bound to be highly inflationary, which inevitably triggered another round of fiscal tightening. Of course, had the government been really pro-active, it could have done a lot more to steer the economy towards energy efficiency sooner. Oil prices have been rising at a sharp rate since 2003. A wiser government could have done much more to invest in drip-irrigation and solar water pumps to reduce oil-dependance in agriculture. It could have done more to solve the power shortages, and steered domestic consumers and small retailers towards invertors instead of generators. It could have mandated malls and developers of high-rises to build green. But it left everything to "market" forces - even while distorting the "market" with a foolish regimen of populist subsidies that every economist knows are inflationary. It compounded the problem with more (off-budget) populist election give-aways that are now threatening to hurt the whole nation. But even as the government stumbles, its detractors must also learn the right lessons. Part of India's inflation problem stems from an economic model that has never been entirely realistic or up-to-date. At present, India's economic pundits are still working with models developed in 1993 and seasonal data is neither precise nor detailed enough. Some economists have been arguing that it has under-reported growth by 10-15% because it relies on an outdated mix of industries to gauge growth. Others have pointed out how it does not take into account the enormous volume of black money that fuels much of India's real-estate and entertainment industry. As a result, government data provides a very inadequate picture of the real economy. This can lead to serious economic miscalculations, misdiagnosis (of problems) and misallocation of capital and resources. Nevertheless, some conclusions are fairly apparent. In a globalized economy, rising fuel costs can percolate very rapidly. Transportation costs alone can multiply quickly leading to very rapid inflation in a country like India (which is situated relatively further away from most major commodity producers. China (which can tap into the vast commodity reserves of neighboring Russia or Central Asia) has a distinct advantage. Likewise, most developed consumer markets are proximate to China, rather than India. Russia, Korea and Japan are neighbors. Australia, Canada and the US are closer. To follow China-like policies is most unlikely to yield the same dividends for India, but it could greatly increase the risks for the Indian economy. This is a lesson that has yet to sink for most Indian policy makers. Even some of India's "left-leaning" analysts have failed to take into account key geographic differences between India and China. Given India's relatively isolated location, and the general paucity of land and resources, India must develop in a much more careful, and planned manner. Its economic management needs to be far more judicious than the cheery neo-liberalism pursued so far. Take the SEZ policy. Building SEZs far from vital resources - where infrastructure is already under heavy strain is simply foolhardy and potentially very inflationary. Instead, if SEZ's are considered necessary - they must be located closer to where India's raw materials are more readily available and where excess labor is abundant - as in Bihar, Orissa, Jharkhand or Chhatisgarh. At the same time, India's duty structures must be designed to maximize high-quality local manufacturing that minimizes energy and transportation costs. Macro-economic tightening is simply no substitute for inadequate or bad planning or fiscal irresponsibility. (The recent fiasco over Bangalore's international aiport is just one example of how poor planning can not only lead to great frustration and dissatisfaction but also higher costs that eventually crimps the growth potential of the region. Advance planning can be especially important prior to the creation of private monopolies since even a change of government cannot easily rectify problems that may arise unless one is bold enough to renege on private contracts that are so clearly against the public interest or savvy enough to blacklist such unresponsive vendors from future economic activities). Inflation can be a reflection of structural or physical bottlenecks arising out of poor planning. Or it can be an indicator of the level of parasitism and mismanagement in an economy. It can be the result of too much money in the hands of entities who have not earned it through adequate productive contributions to society. Fiscal tightening is a poor tool when it comes to reining in corruption and the black money that is often fueled by disingenuous government policies or poor implementation of well-intentioned policies. India's fiscal managers rarely take into account the consequences of endemic corruption when government funds intended for development and social welfare are repeatedly siphoned off by unscrupulous government officials and ruling-party cronies. Whether it is political corruption, or the growth of private cartels, or electorally-driven populism - the effect on inflation can be similar: too much money in the hands of the non-productive (or less productive); ultimately, that must lead to inflation because it is unaccompanied by concomitant increases in real productivity. A high-interest rate regime does nothing to reduce such economic distortions. If anything, it can compound the problem, because high interest rates can also choke off the more productive sectors of the economy by denying legitimate businesses the capital they need to expand. If inflation is primarily the outcome of the growth of parasitic entities, then any reduction in loan availability for productive sections of the economy will only aggravate the situation. Unfortunately, not only has this government been a contributor to the problem, it is not at all evident that it has the understanding or wherewithal to effectively grapple with the problem in its entirety. Its continued reliance on traditional interest-rate management regimes does not generate much confidence. In the end, India's inflation challenge may require good governance much more than traditional fiscal measures. It will probably require a government that has a much deeper inderstanding of India's internal and external realities. It may require a more introverted look at the economy. While it is important for India to engage with the rest of the world on terms that will be beneficial and advantageous to India's future progress, mindless and myopic dependance on a cut-throat globalized world is simply idiocy. One need not confuse greater self-reliance with insularity. As a resource-scarce nation, India's growth can be sustainable only if it is accompanied by the greatest frugality in resource use. That will require constant scientific, technological, and managerial innovation. It will require focused attention on population control, building social and physical infrastructure and very advanced levels of urban and industrial planning. It will also require rewards to be based on productivity and genuine social contribution. All forms of parasitism - whether arising from political patronage, cronyism, nepotism or casteism must be actively fought and shunned. India's workplace must be free from any discrimination - whether it arises from gender bias or socio-cultural chauvinism or just plain bigotry. In the modern workplace, there ought to be no discrimination based on natural differences or those based based on lifestyle or sexual orientation. There must be a healthy respect for knowledge, skills, creativity and just plain diligence. The only way for India to overcome its resource scarcity is through enlightened policies - policies that enhance the human spirit - the potential for excellence and mutual cooperation - that maximize the impact of our traditional knowledge systems with the best that modern science and technology can offer. In a globalized economy, for a resource-constrained nation, inflation is not merely a fiscal problem - it is an all-encompassing problem that will require some deep and long-lasting structural and civilizational adjustments in society. False idealogies and old prejudices will have to be sacrificed. Truth and the scientific method will have to be bravely embraced. That is how the demon of inflation will be vanquished. Mere tinkering with interest rates may not cut it. Related
Essays: Inflation and Import Substitution
Farm Suicides and Electoral Populism Problems of
Indian Agriculture The Sonia-Manmohan Government: A Report Card The Colonial Legacy and India's Knowledge InfrastructureHigher Education in India What Ails Khagaria? Human Development and Infrastructure in the Indian Subcontinent Back for other selections from South Asian Voice for other articles on issues confronting India and the region. Also see South Asian History or Topics in Indian History for relevant essays that shed some light on the history of the subcontinent. (If you liked our site, or would like to help with the South Asian Voice project and help us expand our reach, please click here) To send an e-mail, write to india.resource @yahoo.com
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