The government’s claim that it will dampen inflation, bring higher
prices for farmers and lower prices for customers may be somewhat
exaggerated
With the intention of signalling a strong commitment to reforms, the UPA
government has announced a hike in the price of diesel and
liberalisation of foreign direct investment (FDI) in multi-brand retail,
justifying the measures as growth-enhancing and inflation-dampening.
They have been termed bold by India’s corporate sector and burdensome by
an Opposition united across the ideological spectrum. In his speech to
the nation on September 20, the Prime Minister stated that the
government’s move is motivated by concern for the ordinary Indian. Given
the conflicting responses, there is room here for analysis.
Strengthen infrastructure
The interesting thing about public sector pricing, in this case of
diesel, is that keeping prices steady as input costs rise would be as
political in content as raising them is. As stated in an editorial in
this newspaper some days ago, the government need not have waited so
long to raise the price. It would seem that the government had no
intention of doing so while Parliament was in session. Be that as it
may, there is a strong case for eliminating the subsidy on all fossil
fuels and transferring the saving thus made into public infrastructure.
Apart from the symbolism of soaking the SUV-driving rich, the building
and maintenance of public infrastructure are more likely to help the
poor — presumably the PM’s aam aadmi — than the current regime of subsidies.
The creation of infrastructure employs the poor directly as it is they
who build it. Secondly, the provision of the producer services afforded
by the infrastructure sustains private economic activity which generates
employment. The idea that the poor would benefit more from public
investment than the present subsidy regime, described by some as welfare
state for the rich, has not really been sufficiently debated. For
India’s political class, subsidies are the easiest path to being seen as
benefactors while being relieved of the task of managing the process of
building and maintaining infrastructure, arguably a non-negotiable
aspect of governance in a democracy. So, even a small hike in the price
of diesel can be the beginning of a realignment of government
expenditure from consumption subsidies to investment in infrastructure,
and the poor may be expected to gain from this. Finally, the gains from
macroeconomic stability cannot be legitimately ignored when evaluating
the prospects for the poor. Macroeconomic instability spares nobody, and
India’s current account deficit by now exceeds the figure for 1991.
Fuel subsidies have enormous consequences for the balance of payments,
as 80 per cent of our oil consumption is imported.
When it comes to FDI in retail, the beneficial impact on the aam aadmi
is altogether less obvious than in the case of lowering the diesel
subsidy. What FDI in this sector may be expected to do is to take the
shopping experience in India to the next level. Surely, cavernous
supermarkets make it easier to shop for those with deeper pockets.
Precisely because the supplier caters to this cohort the quality of the
groceries may be expected to rise. In fact, we have already seen this
happening, even without FDI, with organised retail spreading in India.
But those on a daily wage and no ready cash are unlikely to patronise
these suburban behemoths. They may be expected to prop up the kirana
with its infinite capacity for apportioning their stuff to suit the
customer’s purse and willingness to extend her credit. So the Opposition
may well be crying wolf over the imminent disappearance of the corner
store.
But the government’s claim of a ‘win-win’ with higher prices for farmers
and lower prices for customers with the advent of FDI may be somewhat
exaggerated. For precisely because the large retailer must cut through
the supply chain to deliver this outcome, there would be some
displacement in the middle. The government counters this reasoning by
pointing to investment at the backend, in cold storage and such. This is
possible of course, but we would want to wait and see the full combined
effect once all effects have worked their way through the economy. Some
part of the corner-store complex will survive purely because there are
too many poor people in this country yet, generating a substantial
demand for low quality food with lower mark-ups. But the position that a
policy is only as good as its direct impact on employment is surely
untenable. To reject outright a move on the grounds that it does not
directly put the poor to work would be folly. Productivity growth is
often first employment displacing but it also lowers prices and raises
demand. The point is that it not only raises demand for the good in
question but for all other goods in the economy, as real income is
higher following the rise in productivity. Overall employment in the
economy may be expected to expand.
Little to offer
It is when it comes to inflation though that the present round of
announcements by the government has little or nothing to offer. The
suggestion, first made when the proposal was mooted some months ago,
that FDI in retail would dampen inflation is difficult to fathom. The
source of the current inflation is a veritable excess demand for
vegetables and a manufactured excess demand for the principal
foodgrains. The latter stems from the government’s procurement and
storage policy. By mopping up almost the entire marketed surplus of
grain as it comes into the wholesale markets and then allowing it to rot
by unaccountable stock management, the Government of India abets hunger
in the name of supporting the farmer. The entire political class is
united in not calling attention to this travesty.
The RBI’s argument that the fiscal deficit is the source of the
inflation may deflect attention from its own incapacity in the present
context, but does not do much to enhance our understanding of policy
options. The Central government’s fiscal deficit is lower today than it
was when the present bout of inflation commenced about two years ago.
Thus the hike in the price of diesel would have to be justified on
counts other than its presumed impact on inflation via a lower fiscal
deficit. The current inflation is rooted less in macroeconomic
imbalances than in structural ones emanating, as explained above, in the
market for food. As a corollary, macroeconomic intervention via fiscal
or monetary policy can have only a limited impact. As an aside, they can
only compress output, a sequence of events playing out in the guise of a
slowing manufacturing sector. It is by now clear that only
microeconomic policy intervention can make a difference to the food
situation and thus inflation. In India the cost of producing food is
high in relation to per capita income. FDI in retail can make no
difference here. It can at best only deliver more efficiently what has
been produced at cost. The government can hardly be accused of not
knowing of the importance of micro interventions.
For instance, it has been observed that vast sums of money spent by the
government on irrigation were not showing up as increase in irrigated
area. This was at least five years ago. Now there are reports of an
irrigation scam involving Rs 20, 000 crore in Maharashtra, a State for
all purposes governed by the UPA. It is quite extraordinary that the
current food-price led inflation has been in existence for over two
years now and the government has not been able to come up with a single
measure addressing it, even if its impact may be felt only in the medium
term. When it is not actually stoking inflation by raising the
procurement price of grain it comes up with window dressing in the form
of FDI in retail.
It would be appropriate to conclude by asking whether the government
makes too much of foreign investment, desirable as it is. With respect
to its heroic recent announcement, there is the issue of the suppliers’
response. Walmart’s Asia President Scott Price is reported to have
already stated “we are not in any rush” to enter India. But there is a
query more general than the likely response of foreign investors to the
overtures being made presently. In the two decades since 1991, India has
not attracted much FDI, giving us an idea of what may be expected in a
future with or without FDI in retail. Some perspective is to be had from
looking at the Chinese experience. For an idea of the relative roles of
FDI and domestic investment in generating growth in that country, note
that FDI as a share on the domestic product had peaked in 1993. It was
only 6 per cent even then, and has declined progressively since to a
figure less than half that. This suggests that China’s double-digit
growth cannot be explained by alluding to the FDI it attracts. Is our
own government overrating the power of foreign investment to transform
India’s economy?
(The author is on the faculty of Economics at the Centre for
Development Studies, Thiruvananthapuram. He may be reached at
www.pulaprebalakrishnan.in)
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