India’s Inflation Problem

India’s Inflation is getting worse every day.  And somehow Fiscal policy and Monetary policy “don’t talk to each other”.

The level of corruption and the inadequate fiscal responses are taking the nation in a direction that can undo most of the growth projections touted by the Government and some overzealous economists.  Interesting Article.

Inflation isn’t going back to the old normal any time soon, for several reasons. Start with food. India is structurally short of food supply, the 4-5% annual agricultural growth not enough to satisfy the surging demand of 1.2 billion people with real incomes rising at over 5%. Many woes can also be traced back to an inefficient supply chain, which is severely restraining capacity. Late last year, the government’s effort to partially address this problem with foreign investment in retail spectacularly tanked. This just raises the stakes to improve productivity and supply chain efficiency. Without this, some prices—especially food—will remain sticky, as the same amount of money chases fewer goods.

Making matters worse are the government’s rural jobs and agricultural procurement policies. India’s expansive rural unemployment assistance program, which guarantees 100 days of work a year, has pushed up rural wages like nothing before. Real wages rose 10% year-on-year in January 2010 and accelerated further to 14% by May 2011. In contrast, they were virtually flat between 1999-05 and grew at an annual 2% over 2006-09. These wage increases are not because productivity is increasing, but because the government is handing out more money without getting much output in return.

Since these wages got indexed to inflation in 2011, this welfare program has actually institutionalized a vicious wage-inflation spiral. Higher food inflation now automatically translates into higher wages that raises input costs for all goods. This economic shockwave causes a bigger one: The government raises the administered floor price for many agricultural products and increases food inflation further. Since rural wages act as the benchmark for construction and informal workers, wages in urban areas have risen in tandem.

These are structural problems that need fiscal responses, which is perhaps why monetary policy hasn’t been entirely effective. Take this year. Much of the impact of the RBI’s tightening was undone by the fiscal deficit expanding by 1-1.5% of GDP and adding to demand. In the face of falling inflation and a rise in growth concerns, the RBI has found it hard to keep monetary policy on a tightening bias, suggesting that the central bank’s target has shifted from a ceiling on inflation to a floor on growth.

via Jahangir Aziz: India’s Intractable Inflation – WSJ.com.