Inflation in India - Fuelled by Demand

INFLATION IN INDIA: FUELLED BY DEMAND?

 (Download)

Recent spurt in prices came as a rude shock to the government which was preparing to take on the serious economic challenges like tumbling of the stock exchanges in the country and global slowdown. In a democratic system like ours, nothing can be more worrying to the party in power than the soaring prices in an election year. Surprisingly, the inflationary pressure is coupled with the reduction in economic growth of the country, and defying the principles of monetary theory, the Indian economy is behaving like a typical developing economy. By the end of March, the inflation rate had reached an alarming 7.41 per cent level and has been hovering above 7 per cent thereafter.

No one need to scratch one’s head to find out the reasons for the price rise in the recent weeks, despite several desperate measures taken by the government to control it. First and foremost is the global environment. Globally, the prices of food articles have risen by about 75 per cent during the last about six months. The situation is so precarious in the African continent that groups of people suffering from hunger in several African countries have tried to loot the foodgrain stores of the government and the other organisations.

The world community became even more concerned after the recent report that the world has been left with food stocks only for three to four weeks. Sharad Pawar, the Agriculture Minister of India was quick to respond to the above report and announced that the situation was under control in the country, as the buffer stocks of food were more than the prescribed limit. But notwithstanding the said assertion by the Agriculture Minister, the prices of foodgrains, edible oils, pulses, fruits, vegetables etc. continue to head northwards.

In India, agriculture sector is growing at the rate of around two per cent while the growth rate of population is also around two per cent. In other words, more people in the world are chasing lesser food articles, resulting in pressure on the prices. In addition, the world economy is also trying to pay attention to the sectors having high growth potential and the primary sector is getting ignored. India has not been an exception in this regard.

Global prices of crude oil have been on the rise during the past about two years now. Towards the end of April, the crude oil prices in the international market had crossed $ 120 per gallon, putting pressure on the government to increase the retail prices of petrol and diesel in the country. Increase in the prices of these products has cascading effect on the prices of other commodities due to increase in the transportation cost. This has been one major factors responsible for higher inflation rate in the country.

Another factor responsible for the constant increase in prices has been the rising prices of cement and steel. This is perhaps due to increased demand for steel and cement due to increased construction activity, infrastructure development through various flagship programmes of the government and increased demand for these commodities for such programmes and the activities of the National Highway Authority of India. Increased steel prices put pressure on the prices of many products that use steel as raw material, including the automobiles, construction industry and other such industries.

Defying Monetary Policy ?

As per the monetary theory, inflation is largely a monetary phenomenon and it is the monetary policy measures that come to the rescue of the government to control inflation. In developed countries, it is the increased money supply that generally causes inflation and the government takes monetary measures like increasing the bank rate, Credit Reserve Ratio (CRR), increasing the deposit rates to mop up the surplus flow of money in the economy. Traditionally, inflation in India has generally defied the monetary theory and has refused to be curbed by the monetary measures.

The economy has been growing at around 8 per cent per annum during the past five years and the forecast for the current financial year is also around eight per cent. But, on the other hand, the prices of food articles, cement, steel and oil are on the rise. Though the agricultural sector has been growing at slower rate of around 2 per cent per annum, other sectors like the manufacturing and the services sector are booming with a growth rate in double digits. All these factors contradict the teachings of the monetary policy.

Another principle of the monetary policy is that the price rise due to increased money supply of one commodity is offset by the price fall of another. In a poor and agrarian country like ours, where majority of the people spend major chunk of their earnings on food articles, this cannon seems ridiculous. With food scarcities galore and the food prices soaring, it is immoral to say that the increase in the prices of food articles is offset by reduction in the prices of other goods, say cosmetics. People need food at every cost and not the cheaper cosmetics!

The above phenomenon has forced the policy makers to control inflation by moving away from the monetary policy measures to other measures. One of the most frequently used measures has been the changes in the import-export policy. To tackle inflation, India has often resorted to the policy of reducing the import duties on the food articles, on the one hand, and banning the exports of the select food items, on the other.

Recently, Raghuram Rajan Committee had suggested that the Reserve Bank of India should not resort to routine multi-tasking covering the exchange rate, growth and inflation, but should focus primarily on control of inflation. It is believed by many that in the Indian conditions, non-core inflation is often the dominant part of inflation, and under such a scenario, the monetary policy measures are week tools for curbing inflation. The policies which are successful in the European countries may not work in the country like ours and there is no point in blindly following the monetary policy measures as prescribed in the economic (monetary) theory book.

Corrective Actions

The Wholesale Price Index (WPI) is an index of a few commodities and if one looks at the composition of such goods, the prices of several articles have not undergone any change, indicating the inflation rate at 7.41 per cent as on 29th March 2008.

For example, fertilizers and pesticides have about 10 per cent weight in the index, but the prices of these commodities have not undergone any major change in the last one year. But even if these two commodities are excluded, a significant percentage of index representing a host of commodities has remained unchanged over the last several months. Electrical goods, for example represent about 2 per cent weight in the WPI and their prices have remained static during the last about eight months.

The above facts indicate that the WPI takes into account the weighted average of the commodities included by the government in it and ignores the prices of the commodities that are excluded from the index. Hence, in the modern day of consumerism, where there are several segments in a particular commodity, the WPI needs to be made broad based to include more commodities. As on today, it does not represent the true picture about the price rise in the country.

For rural and agricultural workers the impact of the inflation has been even higher. Ironically, these categories have very low income levels when compared to the national average. Consumer Price Index (CPI) for the agricultural labourers and rural labourers during the month of March has been close to 8 per cent. Since the calendar year 2007, the CPI for the agricultural labourers (CPI-AL) has been increasing at a much faster rate than the WPI. During April-March 2007-08, CPI-AL has remained higher than the WPI, with the gap between the two being around 3.5 per cent at an average. The reason is that the CPI has higher weightage for the food and consumer items than the WPI. This also explains why the impact of price rise for the consumer is higher than the announced inflation rate by the government. CPI is more relevant to the consumers and not the WPI.

House rents and miscellaneous services have also become dearer than before, adding to the worries of the consumers. As per the latest data released by the NSSO, the most consumed items in the Indian households are rice, wheat, onion, potato, milk, arhar and edible oils. During April-March 2007-08, the WPI of rice increased by 6.35 per cent, arhar by 14.52 per cent, milk by 8.68 per cent, wheat by 5.57 per cent, mustard oil by 28.91 per cent and coconut oil by 10.8 per cent.

Increased prices of the food articles are attributed to the supply side constraints and the developments in the international markets. Exports have become expensive due to the global price rise. Hence, the government was left with no alternative but to take measures to control inflation directly. The zero import duty facility has been extended to the import of several food commodities and export of pulses has been completely banned. Further, several State governments like Delhi and Maharashtra initiated several de-hoarding drives by raiding the foodgrain godowns.

Being in the election year, the UPA government at the Centre can ill-afford to let the situation of price rise prevail and perpetuate. The measures have begun to show some results when the inflation rate eased to 7.14 per cent during the week ending April 5, 2008. It is felt that a spell of good monsoons would further improve the position, while the failure of the monsoons may spell doom not only for the farmers, but also for the consumers.