The government's assurances and projections on prices cannot be taken at face value. We are told that inflation is under control, and will subside to 7 per cent by the end of the fiscal year. The Reserve Bank of India, in its February bulletin, highlighted that: “While the inflation path is broadly evolving in line with the 7 per cent projection for March 2012, upside risks persist.”

As if to lend strength to its cautious optimism, the January numbers of the wholesale price index (WPI) show inflation at 6.55 per cent and the inflationary build since April 2011 at 5.48 per cent. Even if you forget upside risks, how credible is the 7 per cent projection?

Going by another measure — the GDP deflator — inflation by the end of this fiscal would be 8.8 per cent. The advance estimates for GDP growth this year at factor cost are 6.9 per cent at constant (2004-05) prices and 15.7 per cent at current prices. Unlike WPI, the GDP deflator also includes services sector inflation.

Yet, it is strange that the policy literature of the RBI and the Finance Ministry is silent about inflation in services, even as services accounts for nearly three-fifths of the GDP. That services sector inflation numbers are available only on a quarterly basis, does not justify their exclusion from the public documents of the RBI and Finance Ministry.

IMPACT ON BUDGET

Be that as it may, let us first look at the effect of using a wrong inflation figure in drawing up the Budget. This is evident in the current year's Budget, which bases its estimates on a nominal GDP growth of 14 per cent, made up of a real growth rate of 8.4 per cent and an inflation rate of just 5.6 per cent. This assumption is evident from the following passage in Economic Survey 2010-11: “Indian economy is expected to grow by 8.4 per cent in 2011, following a growth of 9.7 per cent in 2010.”

The anticipated nominal growth rate may be higher at 15.7 per cent, but a higher inflation element (8.8 per cent) erodes the credibility of the Budget numbers.

Even if an underestimation of inflation does not alter the fiscal deficit as a percentage of GDP, it should be remembered that the welfare outcomes of the expenditure incurred are lower as a result. Therefore, the government should be less conservative about its inflation estimates, if it is to be sincere to its Budget-making exercise.

It should also spell out, at the outset, how it arrives at the expected rate of inflation, instead of not mentioning that figure and leaving it to the people to figure it out.

PRICING POWER

Now, to services sector inflation, derived from the GDP deflator. Except for the trade, hotels, transport, communications and storage sector, which has recorded an inflation rate of 7.6 per cent in the first half of the current fiscal, all the other services have recorded an inflation of 9-10 per cent during this period, thereby contributing to an overall inflation rate of 8.8 per cent.

Leading the pack is ‘‘financing, insurance, real estate and business services'' with 10 per cent, closely followed by ‘‘community, social and personal services'' at 9.9 per cent.

It is possible that the price-fixing power of a sector plays a major role in the level of inflation. That might perhaps explain why the trade and hotels sector, which is competitive and fragmented, has a lower inflation rate than ‘‘financing, insurance and real estate' and ‘community and social services''. Property, health and education are sellers' markets, unlike trade and telecom.

It is surprising that the ability of each sector to determine prices does not find a place in the policy discussion. The RBI merely draws attention to the HSBC-Markit Purchase Managers Index to “indicate that the pressures on input costs have been higher than the pricing power of output.” How valid is this observation for all sectors?

While arriving at the right set of policies to deal with growth and inflation may take a long time, the RBI and the government should at least be more open about their policy assumptions.

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