Deficit disorder

Low industrial production and high inflation are reasons to focus on fiscal correction, skirt populism

From the point of view of investments, the fourth quarter tends to perform better than the preceding three quarters in the Indian economy. It is possible, therefore, that the sustained downward movement in the index of industrial production, which has reached 0.7 per cent for the April-December period of this fiscal, could improve somewhat in the last three months. Even with the improvement, however, achieving the growth target for this fiscal will remain difficult. For instance, as per the latest data released by the government on Tuesday, the mining sector has contracted by 1.9 per cent. To ensure the 0.4 per cent growth estimate for the April-March period, the sector will have to expand by 6.4 per cent, January to March 2013. The backlog for manufacturing looks less daunting, which must expand by 5.3 per cent in each of the three remaining months.

Figures showing sluggish industrial behaviour present more of a worry when juxtaposed with the retail inflation numbers, also released on Tuesday. With the RBI projecting a rise in the price levels for the December-January period, the spike was not entirely unexpected. Retail inflation in India tends to peak around these months. The area of concern is a higher rate of inflation in rural areas, at 10.88 per cent, even as urban inflation is not rising at the same pace. This inflation cannot be entirely accounted for by the rise in fuel prices. Whatever be the proximate causes, the combination of low industrial growth and high inflation makes policy prescription tricky.

The government would like to tackle the slowdown in industry by creating more demand. This means more supply of money in the economy. But a higher flow of money will inevitably push up the inflation rates. This is a difficult choice for the government as it runs the risk of hurting the poor in the prolonged run-up to the general elections. Some of the pressure of this trade-off can be removed if the fiscal deficit comes down and room is created for the private sector to borrow more in the space vacated by government. This is why the finance ministry's focus on reducing the deficit is crucial for the economy. This is also why the poor have a stake in reducing, rather than expanding, public expenditure financed through borrowed money. This could mean that keeping in abeyance high expenditure plans, like the food security bill, would actually work in favour of its intended beneficiaries.

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