Price rise hurts. It should be managed, however, in a way that does not throttle economic growth. The bright student gets tired of studying long hours. Parents do not ask him to reduce the studies. They provide him with nutritious food and help him to study yet more. Likewise the economy is feeling the fatigue of high growth rate. Reserve Bank of India should not raise interest rates to reduce inflation because that will throttle growth. RBI should let prices rise and force the Government to take appropriate policies to tackle the increases in food-and oil prices.
Immediate cause of the present increase in prices is large inflows of foreign investments. Indian companies are doing well and foreign investors are buying their shares. Indian companies are making ambitious plans of investments buoyed by the soaring prices of their shares. It has become easy for them to raise capital in the domestic-and global financial markets and establish green field factories. These investments are leading to increase in demand for cement, steel, furniture, labour, fuel oil and agricultural produce. The prices of these commodities are rising.
Indian companies are borrowing more from domestic banks to support their investment plans. Typically, a company borrows Rs 200 for Rs 100 that it brings in as equity. The Reserve Bank has continuously increased the rates of interest in the last year to discourage Indian companies from borrowing and making fresh investments. Idea is that reduced investments will cool the demand for cement, steel and other materials and help contain the price rise.
This stance of the RBI is not in the right direction. Objective must be to help the economy bear the side effect of inflation that comes with fast growth. RBI must not slow down the economy that is galloping at full speed.
RBI is concerned that the increase in agricultural- and fuel oil prices may not spillover into the economy and lead to a generalised increase in prices across all sectors. The prognosis is correct. However, it is necessary to examine the cause of increase in prices in these sectors before deciding on the prescription.
Agricultural land is being diverted in large quantities for highways, residential buildings and industries. More land is being used for the production of biodiesel. This is leading to less cultivation of food crops. Matters are being made worse by a shift in consumption from vegetable- to animal proteins. More land is required to supply the same amount of protein from eggs and meat. Less land is required to supply the same from pulses. This diversion of land is causing increase in price of all food items. Solution is to increase the productivity of agriculture. Measures must be undertaken for more efficient use of water. Farmers near the canal head are wasting much water while those at the tail end wait in vain. Facilities for storage have to be made. Roads have to be constructed in the far off villages. Research has to be undertaken to develop new varieties of crops that are drought resistant and give higher yields. Also, there is need to reduce demand for energy by taxing conspicuous consumption of energy so that less land is diverted for production of biodiesel. All these measures fall in the purview of the Prime Minister. Failure of the Prime Minister to deliver is leading to increase in prices.
The second source of increase in prices is fuel oil. Its price is rising on the back of increased consumption by the developing countries. I reckon this increase will persist in the long run. The previous peak price was driven by consumption from the developed countries. Retreat of their economies brought down the prices. The present rise is due to increased consumption from the developing countries. These are less likely to retreat. They still have a long way to go to catch up with the developed countries. The global demand for oil, therefore, is likely to remain robust. The supply of oil, on the other hand, appears to be peaking. New sources of energy are far and few. As a result, mismatch between increasing demand and declining supply is likely to persist. The prices of oil are likely to move up an up. Solution of this problem lies in two policies. One, we should provide encouragement to energy-extensive service sectors like music, software, translations, etc. and discourage energy-intensive industries like aluminium and steel. Two, we should heavily tax consumption of energy. We are using much energy in air-conditioned shopping malls. The monthly electricity bill of the residential house of a leading industrialist in Mumbai is Rs 70 lacs. Big cars are burning much oil unnecessarily. This consumption must be reduced. Alas! These policies fall again in purview of the Prime Minister. RBI can do nothing here.
The problem before us is like this. The present increase in prices is mainly fuelled by high rates of economic growth and the inflow of foreign capital that it brings along with. We should do nothing to derail this growth. This price rise is side effect of economic growth. We should increase the capacity of our people to bear this price rise. An increase in the wages paid under MNREGA will lead to overall increase in wages of the poor and help them face the price rise without derailing economic growth.
The responsibility of containing the increase in prices of agricultural goods and oil rests wholly upon the Prime Minister. The RBI cannot provide funds for development of new varieties of crops. It cannot make canals or design a policy for judicious use of scarce water. The RBI cannot provide incentives for service sectors or service sector. The Prime Minister and his Ministerial colleagues have to implement these policies. The failure of the Prime Minister to implement suitable policies in these sectors is leading to increase in prices here. The RBI is stepping in and increasing the interest rates to compensate for the failure of the Prime Minister. This is wholly unwise. The RBI is throttling the economy because the Prime Minister is not discharging his duty. The country is being put to double loss. We continue to bear the negative consequences of faulty policies in the field of agriculture and oil. Additionally, we lose the high growth rate. This will not do. RBI must not increase the interest rates. It should let the inflation increase and force the Prime Minister to act.
The RBI has noted in the Third Quarter Monetary Policy Report that the Government must act to ease supply side bottlenecks in agriculture; to improve the quality of government expenditure; and to reduce fiscal deficit. RBI must tie increase in interest rates to visible and effective action by the Prime Minister on these fronts.