The ghost called inflation is back to haunt the government.
Inflation was the country's Problem No. 1 for much
of India's post-Independence history. But since the
mid-1990s the problem seemed to have gone away. Not
only did the annual rate of inflation measured on
a point-to-point basis decline quite sharply to below
five percent, but food grain and foreign exchange
stocks accumulating with the government made the task
of managing any inflationary threat seem like child's
play.
Recently, however, inflation seems to have once again
become an issue. It all began with reports from the
ground that retail prices of many essentials like
pulses and vegetables were rising, though the official
wholesale price indices (WPI) were not reflecting
the trend. Then came the news that the tendency had
begun to affect staples like wheat. These ''straws
in the wind'' became a cause for concern when it emerged
that government stocks of cereals were depleting,
the harvest was not as good as expected and procurement
was way below target. Finally, the official WPI began
signalling a potential crisis.
The last of these facts needs explication. Even the
most recent wholesale price indices relating to the
week-ending June 10 (released on June 23) do not point
to a disconcertingly high overall rate of inflation.
According to those figures, aggregate inflation on
an annual point-to-point basis, stood at just 5.24
per cent, which is well below the 8-10 per cent rate
that signalled a problem in the past.
There are two reasons for this. First, the ''system'',
long-accustomed to low inflation, now seems less inflation-tolerant.
Taking a cue from international policy trends, the
financial media is already predicting a rise in interest
rates-an expectation that has been endorsed by the
Reserve Bank of India's words and deeds in recent
months. Inflation, it is argued, is a sign that the
system is ''oveheating'' with-in layman's parlance-''too
much money chasing too few goods''. This is seen to
require a hike in interest rates to curb debt-financed
investment and consumption spending. And, as expected,
the yield on government bonds, which leads the trend
in overall interest rates, has been rising. The yield
on benchmark 10-year Central Government bonds has
risen to a four-year high of 8.13 per cent.
The problem here is that higher interest rates are
what the ''system'' fears most. As has often been
noted in this column, India's 7-8 per cent rate of
growth, which the government wants to raise to 9-10
per cent, is based on the availability of plenty of
cheap money. That spurs debt-financed consumption
spending and housing investment. It also allows corporations
to restructure their debt, reducing interest costs,
raising profits and spurring investment in sunrise
sectors. A rise in interest rates could put the brake
on the debt-financed growth spiral.
Low interest rates also support the stock market boom,
which has been misrepresented to be a sign of a healthy
economy. As the recent downturn in global and Indian
stock markets shows, higher interest rates, or even
the expectations of a rise, can badly damage the confidence
of financial investors, drive stock prices down and
wipe out large volumes of illusive paper wealth. The
reason is simple-a lot of speculative investment that
inflates the stock bubble is financed with debt. If
interest rates rise to make it less profitable to
borrow and bet, these speculators pull out, depressing
stock prices and eroding the value of indices misused
as symbols of economic health. Thus expected or actual
increases in interest rates are a threat to the ostensibly
successful trajectory of growth based on debt-financed
spending and symbolised by stock market buoyancy that
the UPA government celebrates.
The second reason why an aggregate inflation rate
of 5 per cent plus is providing cause for concern
is that the aggregate conceals significant variations
in the rate of price inflation across commodities,
with some essentials registering particularly high
price increases. According to reports, in the middle
of week-ending June 23, spot prices of pulses like
chickpea (chana) and black gram (urad) in Delhi's
markets have risen by 40 and 70 per cent respectively,
when compared with a year back. Prices of vegetables
like tomato are soaring in retail and whole sale markets.
And, more recently, wheat prices have also been on
the rise, with spot prices having risen by close to
14 per cent when compared with the corresponding date
of the previous year.
These differentials are visible in the recently released
WPI figures as well, with the point-to-point rate
of inflation between 11 June 2005 and 10 June 2006
varying from as low as 2.9 per cent in the case of
manufactured products to between 9 and 10 per cent
in the case of wheat, fuel and sugar and finally to
as much as 35 per cent in the case of pulses. Since
the commodities subject to excessive price increases,
though few in number, are largely essential consumption
goods, inflation has re-emerged as a problem even
when the average rate of inflation stands at just
5.2 per cent.
Point-to-point
inflation from 11 June 2005 to 10 June 2006
|
All
Commodities
|
5.2
|
Manufactured
Products
|
2.9
|
Foodgrains |
9.5
|
Cereals |
6.1
|
Wheat |
10.3
|
Rice |
2.2
|
Pulses |
34.7
|
Fruits
and Vegetables |
2.9
|
Fuel
Power Light and Lubricants |
9.9
|
Sugar |
9.7
|
Source:
Office of the Economic Advisor, Ministry of
Industry
|
Table
1 >> Click to Enlarge
With the WPI beginning to reflect
these trends, the government has decided to act, by
exploiting the cushion offered by the large foreign
exchange reserves available with the central bank.
On the day before the public release of the latest
WPI figures, it decided to permit freer import of
specific commodities at lower rates of customs duties,
on the grounds that increased domestic supply based
on imports would help dampen domestic price increases.
While an extension of the decision taken in February
to import wheat to shore up depleting government stocks,
the more recent announcement goes much further. It
permits private actual users of wheat like flour millers,
biscuit manufacturers and bread makers to import wheat
duty free till the next rabi harvest. It has allowed
customs duty-free import of sugar till the beginning
of the next crushing season which starts in October.
And it has put a ban on exports of pulses. All these
are expected to augment domestic supply and dampen
inflationary price expectations.
This knee-jerk reaction to use imports or reduced
exports as a weapon against inflation is of course
based on the premise that international prices rule
below domestic prices and that inflation is the result
of inadequate domestic supply. Neither of this is
necessarily true. Thus, sugar mill owners have claimed
that duty-free imports of the commodity would have
no effect either on domestic supply or prices, because
the landed cost of imported sugar is at Rs.23-24 a
kg well above the domestic price of Rs.18 a kg. And
exports of pulses in 2004-05 stood at just 2.4 lakh
tonnes, whereas imports touched 12.96 lakh tonnes.
The more important issue is whether the government's
move addresses the real causes of recent inflationary
trends. There are a number of such causes. The first
of these is the poor agricultural production performance.
While inadequate purchasing power may have prevented
this from being translated into a situation of supply
shortage relative to demand, this is a problem that
needs addressing. But the focus of the government's
agricultural policy has been that of enhancing credit
to agriculture. However, credit has often proved more
a problem than a solution, since returns to farmers
are inadequate to meet repayment commitments, as reflected
by the spate of suicides by debt-encumbered farmers.
Moreover, small and medium farmers are often unable
to access credit even when it is available in principle.
What is needed is to increase public investment in
agriculture-a policy alternative precluded by the
government's refusal to garner more taxes and its
commitment to sharply reduce its budgetary deficit.
Second, removal of controls on the movements of agricultural
commodities, liberalisation of rules relating to the
operation of private traders and agribusiness firms
and the failure to procure adequate amounts at the
minimum support price has resulted in a situation
where stocks with the private trade are rising while
those with the government are increasingly eroded.
This has encouraged speculative hoarding at the first
sign of an indifferent harvest, resulting in price
increases. Speculation, rather than an actual supply-demand
imbalance seems to be the problem.
Finally, complacence over inflation has prevented
the government from exploiting options available for
absorbing the effect of the rise in international
oil prices, resulting in an engineered increase in
prices resulting from increases in the prices of universal
intermediates like petrol and diesel.
In sum, the problem is not one of excess demand in
all cases but of manipulated shortages and cost-driven
inflation. By trying to deal with these problems with
easier imports the government is only increasing its
dependence on foreign finance to manage domestic inflation,
since it is the availability of such finance that
makes enhanced imports an option at a time when the
country's trade deficit is widening. It is not clear
whether such a policy would be successful. And even
if it is, it would imply that the returns to domestic
farming would be eroded further, aggravating the long-term
deceleration in the rate of growth of agricultural
production. Dependence on foreign finance and a worsening
of the agrarian crisis seem to be the costs of using
imports to exorcise the ghost called inflation.
