Inflated incomes, growth and inflation: Financial Express: 9th December 2011

There is a new dimension to the inflation conundrum. A thought that comes to mind is whether higher prices have also been driven by higher incomes. This is so because, so far, we are talking of cost-push or demand-pull inflation as the causes; and debates, if not policies, have been geared towards this direction. But if incomes or the classic wage-push forces have played their role, then we need to think differently as our growth model has to be reviewed as it affects future scenarios.


Let us look at different segments of the workforce. The organised sector is affected by various factors such as annual pay increases, adjustment to dearness allowance, bonuses, revisions based on pay commissions for public sector employees, Esops and so on. All these increase the spending power, which, in turn, puts pressure on the demand side, and which goes beyond the purview of RBI as there is no leverage involved. Further, the capital market gives steady returns, which are used for spending and reinvestment.


In the organised segment, public sector banks may be taken to be a proxy for the public sector (excluding government). The average salary per employee increased from R3.71 lakh in FY06 to R7.15 lakh in FY11, a rise of 93%. Interestingly, the average pay rose by 53% in the last two years. If we turn to the central government employees in the last two years, the average pay has risen by 29% from R2.61 lakh to R3.37 lakh based on information in the budget and the census of central government employees. A large part of this is driven by the usual increases in salary that are not dependent on business conditions, as well as adjustments for inflation in the form of dearness allowances. Add to this the pay hikes due to the pay commission along with arrears being spaced over a period of time and we do have a fair degree of affluence being added to these incomes.


If one looks at, say, foreign banks, which broadly represent what happens in the higher income organisations, the increase has been around 20% in the last two years, with the average pay increasing from R16.11 lakh to R19.31 lakh. In FY06, the average was just about R7 lakh. Here, the increase in the five-year period has been around 1.7 times. The moderation witnessed in the last two years may be attributable more to the financial crisis of 2007-09 when these organisations became conservative with their pay packages.


Has the same happened in the rural areas? Here it is a tough call on account of absence of information. But, two proxies may be used. The first is the wages paid in the MGNREGA programme, which have risen from an average daily wage of R90 in FY09 to R118 in FY11, an increase of 31%. Although this scheme is not fully utilised by the labour, it nevertheless sets benchmarks for minimum wages to be paid. This upward thrust can be seen in the wages demanded by the labour in rural India.


Second, the food inflation numbers, by themselves, tell us about incomes being earned. Now, in the last five years, prices of primary articles increased by around 75%, of which 47% was witnessed in the last three years. Either way, it means that rural incomes from farming have been increasing by an average of 15% per annum in the last five years, which means enhanced spending power. This has been aided by higher MSPs announced by the government, which sets new benchmarks.


Evidently, there has been a lot of income increases across all segments, which have provided the required fillip. As GDP growth was buoyant, it meant that goods were being produced for consumption. But this has come with a heavy cost of inflation, which is a concern because the traditional tools for price control cease to work if we have wage-inflation. A good example is price of food. When prices rise, and demand comes down, then prices would have to be lowered. However, today this is not the case and consumers are still spending their incomes on costlier vegetables and foodgrains as they have the wherewithal to do so. The fact that salaries have increased down the line—domestics, laundry, chauffeurs, security personnel, etc, are also earning more—means that purchasing power has not really been controlled and we are living with new price levels. It is probably the fixed income earners who are impacted as they get limited recourse from RBI through interest rate hikes.


The major implication here is for growth and the model has to be revisited. Growth has been driven by high incomes and high inflation, albeit unconsciously and is not sustainable in the long run as we run the risk of galloping inflation, if not checked. Somewhere we have to break this chain or else this double-digit rate, which we term by the cliché stubborn, will only keep growing and conventional policy responses will be impotent. This is certainly not a good sign.