Beaten by inflation

The focus on the long-term inadequacies in agriculture as the reason for the recent inflationary surge is to evade rather than address the problem.

WITH the clamour against corruption having subsided temporarily, the government's attention would now turn elsewhere. From the point of view of the ever-referenced common man, it would do well to make one more effort at taming the inflation demon. For more than two years now food price inflation has been at uncomfortably or intolerably high levels of 8 per cent or more. And the same has been true for overall inflation for about a year and a half. Yet, no effective solution is in sight.

The Reserve Bank of India (RBI) Annual Report for 2010-11 released recently has once again flagged this critical problem. It also underlines a significant and unusual feature of the recent inflation syndrome. The focus of inflation has shifted over time across commodity groups, resulting in the persistence of a high rate of overall inflation even when temporary demand-supply imbalances are corrected.

Taking into account the importance of particular commodity groups in the overall commodity basket, it finds that of the 3.4 per cent increase in the Wholesale Price Index (WPI) during April-July 2010, 32 per cent was accounted for by manufactured non-food products, 30 per cent by food articles and 24 per cent by fuel and power. When we move to August-November 2010, a smaller 2 per cent increase in the WPI was due largely to primary non-food articles and minerals (38 per cent), with food articles and manufactured non-food products accounting for a lower 28 per cent each. Fuel and power were not important drivers of inflation in this period. Finally, between December 2010 and July 2011, when the WPI increased by 7.1 per cent, as much as 43 per cent of the increase was due to manufactured non-food products, 25 per cent to fuel and power and 23 per cent to food.

This continuous shift in the focus of inflation suggests that multiple factors imported inflation, administered-price increases, demand and supply imbalances, and speculation must have combined to keep inflation high. This raises an interesting question. Is it mere coincidence that factors like these have combined to keep inflation high over such a long period? Demand-supply imbalances do tend to appear and disappear in systems characterised by uneven development. For that reason their effects can be addressed by short-term measures such as imports. But the factors providing proximate explanations for the ongoing episode of inflation are quite varied.

If there is an element common to them, it is that many of them are the outcomes of economic reform. Consider the many links between neoliberal reform and inflation. India's vulnerability to the effects of changes in international prices has increased with trade liberalisation. Increased concentration due to the dilution of anti-trust measures and reduced regulation tend to encourage a profit-driven escalation in the prices of certain manufactured goods, as is exemplified by pharmaceuticals.

Imbalances between demand and supply of primary products are accentuated by the government's reluctance to release additional food through the public distribution system in order to curb subsidies. The effort to reduce subsidies has also resulted in a continuous increase in the prices of commodities such as petroleum and fertilizer, whose prices are administered. The list is long and almost endless.

What the recent inflation experience suggests is that while the earlier regime of intervention and regulation is criticised for generating a high-cost (and, therefore, a high-price) economy, the processes of liberalisation and deregulation are the ones that lead to a high-inflation economy.

For a government committed to liberalisation and deregulation, this makes the task of combating inflation difficult. Not surprisingly, the government appears to have given up on the task of curbing inflation and is either hoping that it just goes away or that people do not notice. The common man, it is hoped, would learn to live with the phenomenon and somehow adjust. This is reflected in the changing response to persisting inflation. Initially, government spokespersons declared inflation to be a temporary aberration that would fade away. Then they attributed it to non-addressable international factors or to just plain statistics. Since these arguments could not be advanced convincingly for too long, the tendency more recently has been to recognise the problem, express concern and then declare that it is the inevitable outcome of high growth that can be tackled only in the medium or long term.

The argument seems to run as follows: With incomes rising rapidly, demand for a number of commodities is growing, but supply is either not keeping pace or can, in some cases, only adjust over the medium term. Inflation, it is suggested, is a result of this frictional imbalance. It is a cost that has to be paid for the good life. And only the cussed will point out that neither does everybody bear the cost nor do all benefit from the good life.

The one organisation that has, hitherto, chosen to respond to inflation is the RBI. However, it has relied largely on a single instrument. It expects interest rate increases to moderate investment demand, curb debt-financed housing purchases and consumption and rein in speculation financed with credit. In fact, as the RBI admits in its Annual Report, it has been aggressive on the rate increase front over the last year, hiking it by far more than what the market expected. Cumulatively, the repo rate has been hiked by 3 percentage points, from 5 per cent to 8 per cent over the last 16 months.

Clearly, however, the RBI's heavy reliance on this instrument has not helped matters. Prices continue to rise and inflation persists at high levels. So, in a curious turn, the RBI too has attributed inflation to factors that can be addressed only in the medium or long term.

Consider, for example, its emphasis on agriculture in its Annual Report. Recognising the fact that monetary policy cannot serve the inflation reduction objective unless complementary policies are put in place, the report emphasises the need to relax supply constraints in the agricultural sector.

RBI prescription

According to the RBI, inflation reduction needs improved supply response for food, higher storage capacity for grains, cold storage chains to manage supply-side shocks in perishable produce and market-based incentives to augment supply of non-cereal food items. This has to be complemented with better management of water as also technical and institutional improvements in the farm sector and allied activities. Land consolidation, improving land quality, better seeds, irrigation, harvesting technologies and supply chains to retail points, all can contribute to lowering inflation and the inflation expectations that are formed adaptively.

The importance of many (if not all) of these cannot in themselves be doubted. But to focus on these inadequacies in agriculture that have been accumulated over the long run as the reason for the recent inflationary surge is to evade rather than address the problem.

The concern even in areas outside agriculture is far removed from the immediate problem. Recognising that the transmission of inflation from abroad has also been an important element in keeping inflation high, the report makes a case for paying attention to fuel and food security. What needs to be done towards that end? There is a need for environmentally sustainable solutions to manage energy security, says the report. Finally, with respect to manufactured goods, it calls for a study of the industrial organisation structures, which, together with the competition policy and price information, can help stamp out anticompetitive practices and collusive behaviour that contribute to inflation.

Clearly, other than tinkering with interest rates, the RBI has no immediate solution to the problem at hand. It, therefore, focusses on supply-side policies, some of which may recommend themselves but can achieve little in the short run.

This focus on long-run supply side constraints serves three purposes. The first is that it absolves the government and the RBI of the responsibility of addressing the persisting inflation problem immediately. If growth increases demand, then we need to adjust supply to hold prices. That, ostensibly, takes time.

Secondly, this line of reasoning seeks to obfuscate the fact that the growth that occurs bypasses sectors such as agriculture, and in the process exacerbates rather than resolves supply-side problems. Uneven development and disproportionality that contribute to inflation are a part of neoliberal growth.

Third, the argument seeks to divert attention from the link between the current inflation and neoliberal economic policies. Rather, the supply-side argument allows the RBI to advocate further neoliberal reform to remove distorting subsidies (recommended with respect to fertilizers) and strengthen the supply chain (through encouraging large retail). It also, however, argues for free pricing of petroleum products, since a large population cannot be subsidised in an import dependent item. In its view, neoliberal economic policies are not a cause of inflation, but its solution.

As in its belief in the efficacy of interest rate increases, here too it is wrong.