Interest rates & Malthus' prediction

A V Rajwade: Interest rates & Malthus' prediction

A tighter monetary policy may reduce demand and therefore employment generation, meanwhile a world food crisis looms

The third quarter monetary policy review will be eagerly awaited by bankers and other market participants, thanks to the latest inflation number (8.43 per cent in December). The Prime Minister’s Economic Advisory Council has recently increased its inflation forecast for March to 7 per cent. Even this does not seem to factor in the required rise in diesel prices, even as crude oil nears the $100 per barrel mark.

The problem is whether the monetary policy can do much to curb inflation given that the two major drivers are:

(a) Global commodity prices. These may keep rising with economic recovery in developed countries and fast growth in many emerging markets.

(b) Food prices. It is unlikely that people will eat less after yet another turn of the monetary policy screw. The problem is on the supply side, not the demand side, and monetary policy cannot cure it. Incidentally, Rahul Gandhi believes the price rise is because of coalition government compulsions.

A tighter monetary policy can, of course, reduce demand, and hence growth and employment generation, in the non-food sector. As it is, there are enough signs that the deflationary exchange rate, coupled with tightness in the money market, is slowing growth. Industrial growth dropped to just 2.7 per cent in November, an 18-month low. Many other indicators reflect the same trend: the bearish sentiment in the stock market; the fact that corporate profitability in the first half showed no growth compared to a year ago. (To be sure, “real” interest rates in India are the lowest in Asia, and the International Monetary Fund continues to advise higher rates.)

Some economists look at the so-called “misery index”, only half in jest. It is the aggregate of the unemployment and inflation rates. The misery created by, say, 8 per cent inflation and 5.5 per cent unemployment is perhaps much less than 3 per cent inflation and 10 per cent unemployment, although the index level is identical.

This apart, tightness in the money market is likely to persist since the forward margin on the dollar reduces the economic advantage of leading export receipts and lagging import payments in foreign exchange, shifting export and import financing from the dollar to the rupee.

Food prices
A couple of weeks ago, the government announced an eight-point programme to ease food prices. It includes sale of onions, cooking oil and dal by state agencies and setting up mobile markets for farm produce to eliminate middlemen. Though one sees the political need to be “seen to be doing something”, there are doubts about the efficacy of the measures:

One, the state agencies’ record in too many segments including the implementation of various schemes is far from promising;

Two, as far as eliminating the middlemen to significantly narrow the gap between what the producer gets and what the consumer pays is concerned, encouraging organised retail, including foreign direct investment, may be a far better way, particularly if the managerial and financial resources of the investor can be used to build rural infrastructure (roads, cold storages and so on), and reduce wastage. But we continue to drag our feet on this.

But this apart, sharply rising food prices do seem to be a global phenomenon. The Food and Agriculture Organisation (FAO) index has gone up 100 per cent in five years. The FAO has also warned of a repetition of the 2008 crisis as prices keep rising. There have been riots in Tunisia, Algeria and other African countries. Arab countries like Libya, Jordan and Morocco have taken measures to control food prices. The food shortages and hence price rises are, at least partly, the result of natural disasters in Russia, Pakistan, Australia, Brazil, Indonesia — these are all major foodgrain producers. The US has recently cut forecasts of the stocks of key products like corn and soybean sending prices soaring. And, in the European Union, which, for a long time paid farmers for not producing (to keep prices high and stop stocks from rising), there are calls to protect Europeans from high food bills, even as Europe remains opposed to genetically modified food. (A parallel at home: our environment minister has banned the introduction of Bt-Brinjal.)

Surely, the ghost of Thomas Malthus (1766-1834) must be having a quiet laugh. He predicted that as agricultural output increases in an arithmetical progression, even as population grows geometrically, the world will face a major problem in feeding everybody. For a long time, increases in output owing to larger land under cultivation, better seeds technology, farming methods, use of fertilisers and pesticides and the Green Revolution have managed to avoid that spectre. Can this continue forever? In our case, the rise in food prices has a positive corollary too — it transfers income from the non-agriculture sector to the agricultural sector, helping narrow the per capita income gap between the two.

Coming back to inflation control through monetary policy, now that he is no longer the finance minister, P Chidambaram could afford to concede (The Times of India, January 6), “I am not sure whether we understand all the factors that contribute to price rise nor am I sure whether we have at our hand all the tools to control inflation.”

avrajwade@gmail.com
source;business standard