Deflating expectations

Every time the price of onions rises, pundits remind us (here and here) of what happened in Delhi in 1998, when a spike in the price of onions is believed to have contributed to the state election defeat of the Bharatiya Janata Party (BJP). Inflation does appear to matter greatly to Indian voters: “price rise” was the single most important issue for voters in the February 2014 CSDS tracker poll (PDF), followed by “development”, “corruption” and “economic growth”.

Some blame the United Progressive Alliance (UPA) for feeding food inflation via frequent increases in the minimum support prices (MSP) for cereals like rice and wheat in its quest for rural votes. This may therefore have come as a bit of a surprise:

Modi’s declaration is a timely reminder of just how far we are from India’s “Thatcher moment“. India’s political realities do not permit a mass party like the BJP to ignore key constituencies, and this will continue to shape the economic policies of a future BJP-led government.

That said, inflation is a hot political issue and the BJP’s election manifesto claims that the National Democratic Alliance (NDA) did much more to control inflation than did the UPA:

The BJP-led NDA Government’s record of holding the prices is a demonstration of our commitment to break the vicious cycle of high inflation and high interest rates.

Tellingly, the Indian National Congress manifesto has no mention of either inflation or “price rise”.

How to judge? Just as India’s economic growth is linked to the global economy through trade and investment flows (see How bad is the UPA’s economic record?), the prices of Indian goods and services — particularly those that are tradable — are tied to global prices. I therefore compare India’s annual GDP deflator since 1998 with that of developing countries (using World Bank data). The GDP deflator is a better measure than an inflation index (like the Consumer Price Index) because it does not limit its measurements to a fixed basket of goods and services but one that evolves with the economy.

And this is what we find: the NDA clearly was more successful at controlling prices than the UPA. In absolute terms, inflation rose from 4.5% during the NDA period (1998-2004) to 6.2% during UPA1 (2005-09), and further to 8.2% during UPA2 (2010-12).

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But how much of this can be blamed on poor economic management? That’s where the global comparison becomes relevant, and the UPA2 in particular performs poorly here. Under the NDA and UPA1, India’s inflation rate stayed below that of the developing world (although the differential decreased during UPA1). But under UPA2, Indian inflation soared to 2.5 percentage points above the developing country average. This can’t simply be explained away by high oil prices and inflation in food commodities (e.g. wheat and rice) because developing countries were also affected by those.

This World Bank chart shows how India’s inflation rate (in %) diverged quite sharply from other countries from 2009 onwards:

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So why did this separation occur? Plausible reasons include:

  • Fiscal deficit. The UPA sharply increased government spending in 2008-09, in the run up to the 2009 elections as well as to stave off the effects of the global crisis, but found it hard to reverse course and reduce the deficit subsequently for political reasons. Finance Minister P Chidambaram even blamed his predecessor, now President Pranab Mukherjee, last year for this inflationary surge.
  • Food prices. Food inflation has been a big driver of overall inflation in recent years. As their incomes have risen, Indians have consumed greater quantities of proteins such as milk, eggs, meat and fish, and the prices of these commodities have accordingly spiralled.
  • Minimum support prices. Government policies to ensure that farmers receive higher prices for cereals (e.g, rice and wheat) and pulses have also contributed to food inflation.
  • Subsidy reform. Ironically, price increases in petrol, diesel, non-nitrogen fertilisers and electricity aimed at reducing the deficit have helped increase inflation directly, as well as indirectly by making it more expensive to grow agricultural produce.
  • Rural wage increases. The wages of agricultural labourers have gone up rapidly, both because of the rural employment guarantee act and because of higher wages in sectors like construction that provide alternative employment for this section of workers.

Not everyone agrees that persistent inflation is a completely bad thing. Harish Damodaran argues that inflation in India is a consequence of the economic empowerment of lower-income groups.

For now, though, it’s the UPA that seems to be paying a political price for elevated inflation and slow economic growth.

Postscript

Some analysts like Yogendra Yadav do not think that the concept of “price rise” as presented in opinion polls is reducible to inflation. As he wrote in 2009:

In India ‘price rise’ is a way of talking about the lack of purchasing power or insufficient income rather than what economists call ‘inflation.’

If so, then real wage growth might better capture how the state of the economy will affect voting behaviour. But that’s a different study.

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