Mr Chidambaram, falling inflation is not deflation

Apr 28, 2015

- By Vivek Kaul

Vivek Kaul
The former finance minister P Chidambaram writes a weekly column for The Indian Express newspaper. The latest column published on April 26, 2015, was headlined Across the Aisle: Inflation is bad, but is deflation good?.

Normally I never read economic columns written by politicians for the simple reason that you can never expect them to take a line which is different from their party line. And given that one knows what the party line is on most occasions, there is no point in reading the column. In most cases the politician tries to come up with reasons in order to defend the party line, irrespective of the fact whether that makes good economics or not.

But on this occasion I did read Chidambaram's piece because the word 'deflation' caught my attention. The headline of the piece suggests that deflation is not good. Deflation is the opposite of inflation. Inflation is a situation in which prices are rising. Deflation is a situation in which prices are falling. Why is deflation not good? Once people figure out that prices are falling, they are likely to keep postponing their consumption in the hope of getting a better deal in the days to come.

If this happens, business revenues will most likely fall and so will economic growth. As business revenues fall, companies may try and maintain profits by firing people, among other things.

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Those who get fired will spend money only on the most important things. Further, the firings will also have an impact on others who will fear that they might also get fired and in the process postpone expenditure. And so the deflationary cycle will work.

Hence, deflation is bad.

The only thing is that Chidambaram does not define deflation as a scenario of falling prices. As he writes: "Deflation and its consequences:The decline in the rate of inflation could be attributed to many reasons."

Chidambaram essentially talks about a fall in the rate of inflation and defines that as deflation. A fall in the rate of inflation means that prices are rising, only that they are rising at a slower rate than they were earlier. This is very different from prices falling. The term Chidambaram should have used is disinflation, which essentially refers to a fall in the rate of inflation.

A former finance minister and a Harvard MBA to boot, should not be making a mistake in the usage of these terms. This is Economics 101.

In his column Chidambaram goes on to defend the economic policies followed by the Congress led UPA government between 2004 and 2014. Chidambaram writes that the current government has added to the woes of the farmer by "a paltry increase in Minimum Support Price (MSP), inefficient procurement, increase in prices of fertilisers, poor compensation for lost crop etc." He goes on to suggest that the UPA tried to help the farmer in different ways: "introduction of MGNREGA in 2006 to supplement farm income/wages; farm loan waiver in 2008 to give partial relief from past debt; and generous increases in MSP between 2004 and 2014."

Let's look at these points one by one starting with the debt waiver which was made in 2008. The total amount of debt waived off to farmers was Rs 71,680 crore. While this one time waiver did not bring down any bank, it built in a huge moral hazard into the system. Economist Alan Blinder writes in After the Music Stopped that the: "central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it."

The message that was sent to farmers was that in the future there was no need to repay your loans because eventually the government would waive it off. In a country where the banking penetration is low and that remains starved of credit, this was a very short sighted measure aimed at the May 2009 Lok Sabha elections.

Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) was launched in 200 of the most backward districts of the country on February 2, 2006. It was extended to all rural districts from April 1, 2008. The scheme aims at providing at least 100 days of guaranteed employment in a financial year to every household whose adults are willing to do unskilled manual work. The trouble was that MGNREGA essentially became another scheme where money was simply given away without any substantial assets being created.

As T H Chowdhary wrote for The Hindu Business Line in December 2011 "Villages cannot sustain so many unskilled labourers and not-so-literate labour. By creating useless "work" we are promoting dependency among the unfortunate rural, illiterate and unskilled population...An example of the village Angaluru in Krishna district will illustrate how good money is being thrown away for bad results. Out of 1,000 families, 800 had registered themselves as BPL, seeking work under NREGA. So far, it was 100 days at Rs. 100 per day. Even at this, 80,000 mandays of useful work in a year is impossible in a village and that too, year after year." Hence, MGNREGA essentially became an exercise of giving away money without any comparable increase in production and this led to high inflation.

These moves didn't help the Congress led UPA government win many votes either. As Swaminathan Aiyar wrote in a recent column in The Times of India: "The Congress claimed that its farm loan waiver and MGNREGA (its rural job scheme) won it the 2009 election. Really? Congress won only nine of 72 seats in three very poor states where these schemes should have helped most - Bihar, Chhattisgarh and Odisha."

Chidambaram also wrote about the generous increase in the minimum support price or wheat and rice between 2004 and 2014. The MSP is the price at which the government buys rice and wheat from the farmers, through the Food Corporation of India(FCI) and other state government agencies.

Between 2005-2006 and 2013-2014, the MSP of wheat was increased at an average rate of 14% per year. In 2005-2006, the MSP for common paddy(rice) was Rs 570 per quintal. By 2013-2014 this had shot up to Rs 1310 per quintal, an increase in price of around 11% per year.

This rapid increase in the MSPs led to very high inflation in general and food inflation in particular, between 2008 and 2014. As economist Surjit Bhalla put it in a November 2013 column in The Indian Express "For each 10 per cent rise in previous years' procurement prices, there is a predicted 3.3 per cent increase in the current year CPI...When the government raises the MSP, the prices of factors of production involved in the production of MSP products - land and labour - also go up." Food inflation hurts the poor the most. Half of the expenditure of an average Indian family is on food. In case of the poor it is 60% (NSSO 2011).

To conclude, if the policies of the Congress led UPA were so pro-farmer, why did the lose the 2014 Lok Sabha election, so badly? Guess, Chidambaram's next column can try answering that question as well.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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8 Responses to "Mr Chidambaram, falling inflation is not deflation"

V P Joshi

Apr 29, 2015

I do not expect Mr Chidambaram to write the truth. As a congressman , he and others have been fooling the people of India for past as many years only under the garb of being the messiah of poor.

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Shridharan

Apr 29, 2015

And PC is the Finance minister we had to suffer for long years.Another question in point is the DDT on which he simply has no logic or gives a twisted logic. I am simply at a loss to understand is how can the same income be taxed twice which is what happens in the case of DDT. Mr.PC is not only a bad economist but is of questional integrity given the way his son flaunts his wealth.

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JOHN VARGHESE

Apr 29, 2015

I am rally thankful to the writer who has given a vivid picture of the reasons for the sudden increase in prices of food items.Definitely the pumping of enormous money to the unproductive sector through employment generation schemes and lot of subsidies are the basic reasons for inflation.Let wisdom prevail upon the ruling masters to save the economy

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Manish Shah

Apr 29, 2015

Dear Vivekji hope Mr Chidambaram has read your article and is bold enough to come out with reasons why Congress lost last lok sabha election so badly.That should be very interesting. Its all very easy to defend oneself theoritcally with all harvard/ mba education based arguments/ stastics but what ultimately matters is ground realities. ...

Like (1)

Cyril Pereira

Apr 29, 2015

Mr Vivek Kaul may be an eminent economist, but as a lay person I can understand that Mr Chidambaram actually wrote that falling prices which is good per se bring down MSP and that becomes low enough the farmer or producer stops producing because it is not economical and moves away to something else and this creates a cycle that Mr Chidambaram is talking about. MNREGA supplements the income and the demand is kept higher! We cannot rubbish good intentions because some of the State Govts failed to efficiently implement the scheme and build assets and allowed drainage of funds through corruption.
I don't understand economics but I understand the logic of Mr Chidambaram and cannot understand the economics of Mr Kaul.

Like (1)

subbaiah

Apr 28, 2015

i fully agree to mr. vivek kaul,s analysis and point by point explanation. to-day our politicians are for vote bank and chair and not for welfare of people .

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BALAKRISHNAN ABU DHABI

Apr 28, 2015

I thought Chidambarm is different from other politicians.
Unfortunately he also is trying to tell half truth. He is rightly explaining that DEFLATION is not good for a country. But why he is telling this now ? Where is deflation ? If the inflation is dropping a little does it mean that we are heading to deflation ? Do not be cheap ?

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G S Apte

Apr 28, 2015

This is after a long time that, I am responding to article from you in this forum. I also happened to read article of our earlier Finance Minister in Marathi daily today.

It is quite unfortunate to see that, people in India have this mis-understanding that, high inflation is good for economy. It is not at all good because of simple reason that, it makes your Rs. 100 worth only Rs. 10 in 5-6 years if inflation is around 10%. If we look at Developed economies, they also had an era of high growth but still managed to have modest inflation rates of below 5% for very long times. Even if we assume that, by giving higher MSP, farmers would benefit, but do they have access to cheaper food in villages? If the prices are high, even poor people and farmers will also suffer, and precisely that has happened during 2008-2014. It is only now that, even poor and lower middle class people can see that their daily food prices are at least not shooting through the roof, and they have to spend only 5% more than what they were spending in previous month for day to day items. I am not sure how this is not good for economy. Which book says that, modest inflation of below 5% or around 5% is not good for economy?

Also, we need to understand that, population depending on agriculture is still high in India (about greater than 50%) and the contribution of agriculture to GDP is only 18% as per article in English daily newspaper few days back. That means, we need to slowly reduce population of people dependent on agriculture to about 35 to 40 percent or so, so that there is balance in population dependent on agriculture and their contribution to GDP. Now how we can do this? By giving more jobs in rural areas. So that people in rural areas will have more avenues to earn income apart from agriculture.

Now how this can happen? We need more reforms, simple and easy rules to start business, more land to grow business, so that rural economy will also benefit more than now. Jobs are not only created in cities but those are also created most of the time, in semi urban and rural areas as well. For this to happen, inflation must stay between 4 to 6% as stated by RBI Governor from time to time, so that corporate India would have funds to grow business and generate jobs in rural areas. All Indians would benefit by modest inflation in the long run.

Also, using technology to increase agriculture output has to happen apart from giving good MSP to farmers. I am sure that, majority of people understand this and people would appreciate efforts of current RBI Governor and Government to keep inflation at modest level in the long run.

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