Perhaps
more than any other purely economic issue, inflation
has always been a pressing socio-political concern
in India. That is because the vast majority of our
working people receive incomes that are not indexed
to prices, and are therefore directly and adversely
affected especially by the rise in prices of necessities.
Since money wages and the incomes of small businesses
of the self-employed adjust to rising prices only
with a lag, this means that their real incomes get
eroded over time. So inflation has direct income distribution
consequences.
Of
course, periods of slow price rise are not necessarily
always beneficial, even for the poor. If low inflation
is the result of restrictive macroeconomic policies
that reduce economic activity and employment growth,
it can be even worse for the mass of people than moderate
inflation rates that are associated with rising aggregate
income and employment.
Recent macroeconomic policy discussions have been
rather complacent about the issue of inflation in
India, especially given the relatively low rates that
prevailed over much of the past decade. However, in
the past year the increase in the overall inflation
rate, as well as the rise in prices of particular
commodities, have brought into question both the sustainability
of the current economic growth process and the efficacy
of public management of price rise in particular sectors.
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Chart
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The
charts indicate that consumer prices have definitely
increased in the recent past, such the annual rate
of inflation at present is between 6 and 7 per cent.
Movements in the Wholesale Price Index (WPI) show
that the recent rise has been sharpest in food articles,
including food grains, which still form the most basic
of necessary goods. Indeed, for some commodity groups
like pulses, prices have risen by nearly 33 per cent
between January and November this year.
What
has brought about this recent acceleration of inflation
in the Indian economy? In a statement before Parliament
in July (as reported in the Rajya Sabha proceedings
of 24 July 2006) Finance Minister P. Chidambaram claimed
this was the result of three forces. According to
him, two of these are completely out of the government’s
control.
The first factor Mr. Chidambaram described as the
cost-push effect emanating from the hardening of world
commodity prices, such as oil and other fuels, minerals
and metals. With world prices in these increasing,
it is only to be expected that domestic prices will
also rise. However, in fact global oil prices have
been falling in recent times and are now below the
levels of even one and a half years ago. The same
is true of most agricultural commodities, and of some
minerals and metals imported by India. So cost-push
inflation because of higher import prices is unlikely
to explain the rise in Indian prices after June 2006.
The second factor he mentioned was the demand-pull
effect of higher economic growth, which puts pressure
on available supplies and therefore leads to what
he described as a temporary rise in prices. Certainly
there is evidence that rapid growth in some sectors
has put pressure on raw material supplies and may
lead to supply bottlenecks of particular inputs, including
not only raw materials and intermediates, but also
some forms of skilled labour.
However, this process – and the resulting price rise
- is not a necessary concomitant of high growth. It
is worth noting that the Chinese economy has grown
very rapidly for nearly thirty years, with only moderate
inflation. Even in the current year, when the Chinese
economy is apparently growing by more than 10 per
cent in real terms, inflation has been only 1.4 per
cent at an annual rate. So clearly, rapid growth in
domestic demand need not lead to higher inflation.
Further, since China is also a more import-dependent
economy than India, importing a greater proportion
of inputs for manufacturing production, it should
have been more adversely affected by the rise in world
commodity prices that Mr Chidambaram spoke of. Instead,
inflation rates have been lower than in the past!
The third factor that Mr. Chidambaram mentioned is
what he refers to as ''supply shocks'' but which would
be better described as poor management of critical
areas of the economy. Here, in fact, the Finance Minister
probably hit the nail on the head, perhaps inadvertently.
He referred to the mismatch between demand and supply
in important commodities such as wheat, pulses and
sugar, suggesting that unexpected output shortfalls
for these crops led to a temporary rise in prices
which would get mitigated once supplies were enhanced,
for example through imports.
But this is only part of the story. It is misleading
to speak only of crop failures, for what happened
was essentially a policy-created process that was
subsequently mismanaged. The government allowed the
entry of large (and multinational) private players
into the grain trade, and opened up the futures market
for trading in these essential commodities, which
all have a history of hoarding. Having thus allowed
for speculation, the government was then very surprised
when it actually happened.
In wheat, for example, the Food Corporation of India
was unable to procure adequate amounts for the public
distribution system because private players like Cargill
were offering higher prices to the farmers. Procurement
declined by nearly 40 per cent compared to last year
and wheat stocks fell by 20 per cent to less than
7 million tonnes. This was not only inadequate for
the requirements of the government in terms of the
PDS and school meals programmes, but also insufficient
to quell speculative activity in wheat markets when
prices started to rise.
Eventually, the government was forced to import wheat
at prices several times higher than what it had been
willing to pay Indian farmers, and in the meantime
consumers had to cope with rising prices of wheat.
A similar story operates for pulses, except that mitigating
imports have not yet occurred so the price rise continues
unabated.
This is such expensive incompetence that in any country
with real democratic accountability, heads would have
rolled over this. But in India, ministers can talk
glibly of ''supply-demand imbalances'' as if these
were somehow completely outside the purview of government.
The government is indeed now concerned about inflation,
but unfortunately the knee-jerk response has been
to use the blunt instrument of the interest rate.
In the past months, the RBI’s discount rate has been
increased three times, most recently on October 31.
But this affects all productive sectors alike, and
has disproportionately negative effects upon small
enterprises that already find it more difficult to
get bank credit.
Instead of this blanket measure there should have
been more nuanced and directed interventions addressing
the sectors in which speculative bubbles are clearly
visible. The stock market, for example, continues
to be irrationally exuberant, and the imposition of
a capital gains tax at this point could only have
a salutary effect, besides raising more revenue for
the government. The real estate market is clearly
overheating – house prices in the metros are estimated
to have more than doubled in the past two years. Yet
the banking system and the income tax structure continue
to encourage property loans.
Clearly, the recent rise in inflation reflects not
higher growth but just economic mismanagement.
