Inflation and Import Liberalisation

The inflation rate has been falling fairly steadily since the beginning of 1995, and is expected to continue on this path. This has happened despite the increase in aggregate demand arising from the sharp increase in industrial production and the step up in GDP growth. The demand factors which have restrained inflation during 1995 are a lower fiscal deficit( as % of GDP) and tighter monetary policy. On the supply side the continuing growth in agricultural output has played a positive role, and this is expected to continue given the normal monsoon forecast. The freed imports of several commodities such as edible oils, sugar, cotton and rubber also has a restraining effect, though rising world prices have nullified this potential benefit in some cases. As world demand growth is slowing, the impact of these measures will be enhanced. The build-up of food stocks, though it suppresses inflationary expectations, also reduces current supply. It has therefore to be carefully managed over the rest of 1995-96 to ensure a restraining effect on inflation.
Further declines in inflation in the medium term, will depend critically on the fiscal deficit, trade policy and policy for, and investment in, non-tradeable goods. Since the seventies, poor public saving performance and low expenditure productivity, to which the fiscal deficit is related, have acted as a drag on the economy. A sustained reduction in the fiscal deficit of the Centre and States, through a reduction in unproductive revenue and capital expenditures, is essential for simultaneously attaining both higher growth and lower inflation.
Trade policy affects those goods, which are available in international markets and can be readily transported. Most goods fall in this category. The transfer of all these goods to OGL by the end of the eighth plan as envisaged in the plan document, would make it possible to reduce inflation. As the last few years surge in world GDP growth has now plateaued and may even decline in the next few years, this will reduce the pressure on critical agricultural and intermediate goods prices.
There are a few agricultural goods such as pulses and gram in which the world market is very limited or non-existent. Such goods are effectively "non-tradeable", and productivity enhancing investments in R&D and extension, will be needed if supply is to keep pace with demand.
The most critical area of non-tradeable for the future is infrastructure services. The speed at which policies, rules and procedures are changed to attract private investment will determine how far inflation can be reduced. Transparent procedures which generate public support can speed up private investment to fill supply gaps. Power distribution and rail transport, the two sectors in which private entry is still restricted, are most likely to hinder a further reduction in inflation. Privatisation of urban power distribution and entry of private providers for freight and passenger services, coupled with establishment of Independent regulatory agencies are possible solutions.
The average rate of inflation since 1970-71 has been a little over 9% per annum. It was, however, significantly lower than this in the 1950s and 1960s. The average inflation rate depends on the degree of openness of the economy and the rate of increase in productivity.
The eighties were characterised by an average inflation rate lower than, and a growth rate higher than, in the seventies. The policy reforms initiated in 1980 played an important role in this development. Once excess capacity is used up, faster growth can however, generate inflationary pressures. These pressures are most likely to emerge from the non-tradeable infrastructure sectors. The experience of East Asia shows that the correlate on can be reduced by faster policy reforms, better governance, reduced fiscal deficits and increased private including (direct) foreign investment.