Managing Drivers of Inflation for High Growth

RBI deputy governor Subir Gokarn and Prime Minister’s Economic

Advisory Council Chief Mr.C.Rangarajan have warned about the impact of
high inflation on growth of the economy. RBI favors control of inflation at
the cost of growth if the need be and therefore further tightening of interest
rates can not be ruled. RBI’s concern is understandable as crude oil touches
new high as a result of turmoil in the Arab world.

We have come a long way in last two years and full circle from high deposit
rates of almost 11% to present rates of about 10% with lows of 6.5%. This,
in a way, means that all the tinkering of monetary policy by RBI has taken
us round this circle. While RBI is the most competent authority on monetary
policies, the government needs to address the fiscal policies and bring down
unproductive expenditure and tighten controls on schedules of projects to
avoid cost over runs and avoid popular freebies in the times of elections if it
is serious about reigning in inflation. We have seen inflation of 3-4 %
together with 8% growth tag during NDA/UPA I regime. Fiscal
prudence is unlikely to prevail. It is therefore time to look beyond the
monetary policies for managing inflation.

Evolution of IT Industry

In more than a decade since NDA came to power there have been significant
changes in drivers of the economy and hence the drivers of inflation. The
most visible change has been emergence of IT/ITES sector as the driver of
job creation in the economy at unprecedented rates. This in fact redefined
the achievable growth scenario of the entire gamut of services sector by and
large. IT sector has sustained high growth rates of 30-50% for long time and
created massive job openings drawing qualified personnel from all sectors to
meet their needs. IT sector became driver of the job market.

ITES companies offered job openings for even lesser qualified and skilled
manpower at relatively very high costs. Since there was no pressure on
margins, the IT companies started offering higher salaries and perks unheard
of in other engineering sectors. To retain skilled and qualified manpower
and stem the migration, other sectors had to follow the suit. 15-20 % annual
increments have come to stay as against 6-8% of the old economy. IT sector
became most preferred destination for job seekers.

Value Addition Lagging behind Wage Increase

Intra industry competition of IT sector resulted in poaching with offers of

higher salaries with 30-50% jump even for fresher / raw recruits just to beat
the deadlines of the projects. Changing 2-3 jobs in as many years to double
the package has become order of the industry. Same trend reflected for
higher echelons of the IT companies with greater differential. The value
addition by such manpower in perpetual transit has not increased
proportionately thereby creating a backlash in per capita productivity. If
value addition in economy does not keep pace with money pumped in, it has
to result in inflation as more money gets distributed over lesser number of
goods.

Multiplier Effect

Sudden disposable surplus coupled with easy availability of loans drives up

demand for goods and services enabling employees to live on borrowed
money or future earnings. An employee with annual income of Rs 5 lakhs
can draw a loan of 25 lakhs or smaller amounts for house, car and consumer
durables. This definitely has generated growth of real estate and consumer
durable sectors with ripple effect on other allied engineering sectors.

Living on Future Income

However, unbridled disposable surplus on one hand and easy loans on the
other hand, has multiplier effect on “living on future income” as a strategy
for individual growth. Western economies led by US collapsed in 2009 only
due to this approach fueled by the banking system without back up of
adequate ability to repay the loans. While India has weathered the storm
very well due to conservative lending, we are definitely paying higher price
for living on tomorrow.

Benchmarking Against IT Sector

The new benchmark of salaries set by IT industry forced other sectors to

raise the bar. While the number of direct employees in IT sector may be just
about 18 lakhs, (little more than Indian Railways) the opportunity quotient
of IT industry has far reaching impact on standards of living and therefore
has tremendous magnetic effect on job market. Thus raising the bar for other
industries meant considerable impact on per capita productivity. And the
most unproductive sector of all of them is government sector which quickly
seized the opportunity to bench mark their pay scale revision through 6th pay
commission against IT sector. Over night lakhs of government employees,
bank employees and allied quasi government employees got fat arrears for
few years raising the liquidity considerably.

This coupled with ability to get loans, as said earlier, multiplied the total
available money for spending on good and services not produced by extra
money pumped in the economy. While the wage bills skyrocketed, the
productivity or value addition did not keep pace with IT industry. This has
been an important factor and driver for continued high rate of inflation for
last two years.

What Can the Corporate Sector Do?

In the meantime there has been phenomenal growth in other sectors of

economy such as health care, hospitality, real estate and construction, media
and entertainment etc. In fact while IT sector is expected to generate
183,000 jobs in 2011, healthcare sector is likely to add 248,500 and
hospitality sector will add 218,000. So the experience of IT sector in
managing growth is likely to be transplanted in other sectors courtesy HR
managers and top management personnel moving in across the industries.
No doubt IT industry has a lot to share with other sectors to avoid pitfalls of
growth.

IT sector therefore has the onus of taking the lead to set an example in what
other sectors can do as responsible corporate citizens and leaders. IT
industry must evolve a model to sustain and improve their global
competitiveness and work backwards to rein in their higher costs of ever
increasing employees wage bills. At say NASSCOM level, industry leaders
must agree on certain common business practices to keep the heat down.

1. Competitiveness of whole industry should be over riding criterion as

against the competitiveness of individual industry units. The per
capita wage bill / output norms may be evolved and bench marks with
bandwidth set across the levels so that there is a reasonable flexibility
without too much of artificial differential.
2. Members of industry should refrain from unreasonable poaching with
healthy staff turnover across and within the industry. Frequent job
changers should be discouraged so that employees stay on for
reasonable periods for significant learning and therefore value
addition. Suitable norms may be evolved.
3. While changing jobs the jump in package offered should be restricted
across the industry. Moreover, the component of cash increase should
be smaller and larger portion of jump (say in 1:2 proportions) may be
in terms of contribution to PF, Superannuation etc which have no
impact on immediate disposable cash surplus. The massage should go
that the party is over.
4. Annual increments across the industry should be pared down from
current high levels to reasonable levels.
5. Temptation to pay big bucks to get talent must be resisted and
moderated. Higher levels may be exceptions as they are few in
numbers.
6. Salaries may be benchmarked against new emerging threats from
other developing countries so as to sustain competitive advantages in
long run. This may bring the benchmark down for good.
7. Periodic reviews at industry levels for midcourse corrections may be
necessary.

Other fast growing sectors should evolve similar approaches and plan for
sustainable growth in job creation without losing competitiveness of the
industry. Associations of industries like NASSCOM, CII and FICCI
should spread the culture to keep India on global competitive map for
different sectors of economy.

The Government Sector

Will the government sector bite the bullet? Do they have any road map
for higher productivity? Will they ever reduce their expenditure?
Unlikely though. On the other hand they will keep compensating
employees for inflation with calibrated increase in DA with falling
productivity.

The Way Out

Well, inflation hardily concerns the government in spite of the most

qualified economist being the prime minister. And with elections round
the corner, more money is likely to be pumped in sending inflation
soaring further. As long as the net real interest rate on deposits after
adjusting inflation is in the negative territory, the hard earned assets of
common man are under threat of shrinking. So high growth rate coupled
with high inflation, as feared by RBI, is a sure recipe for disaster waiting
to happen. Every 2-3 years either there are assembly elections or Lok
Sabha elections. We therefore should not expect government to do much
about inflation. So the common man must cheer up and do something
about it.

Higher productivity with lower costs is the basic mantra for managing
and sustaining high growth and should be the guiding factor. Will the
corporate sector pick the gauntlet and lead the way?

Vijay M. Deshpande
Corporate Advisor,
Strategic Management Initiative,
Pune 411021

April 6, 2011

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