Policy paralysis and inflation

Published : Feb 11, 2011 00:00 IST

AT BAITHAK KHANA Bazar, a wholesale and retail market in Kolkata. A file picture. - ARUNANGSU ROY CHOWDHURY

AT BAITHAK KHANA Bazar, a wholesale and retail market in Kolkata. A file picture. - ARUNANGSU ROY CHOWDHURY

The persistence of inflation sends out the message that economic governance under a government populated with economists of repute has broken down.

INFLATION, which had been officially declared as being on the wane, is back and raging. Focussed on food articles, it is eroding the real incomes of the poor and, therefore, the popular support that brought the United Progressive Alliance to power for a consecutive second term. Particularly damaging is the fact that high inflation has been the norm for a year now, with its incidence shifting across commodities, but most often falling on one or other set of food articles. The government seems to be helpless and just wishing that the problem would go away.

Addressing a Chief Ministers' conference on food prices in early February 2010, Prime Minister Manmohan Singh declared: The worst is over as far as food inflation is concerned. I am confident that we will soon be able to stabilise food prices. Three months later, on more than one occasion, government spokespersons, including Chief Economic Adviser Kaushik Basu, declared that inflation had peaked out and was on a downward trend.

Such statements are not surprising since in the current dispensation government representatives at the highest level are expected to talk down prices and talk up markets. It is not what you say but the confidence with which you say it that matters.

But there is reason to believe that the government did actually think that inflation would follow some sort of a cycle and more likely moderate quickly than rise significantly. One or two predictions of an impending price decline are understandable. But, over the last year, almost every month or even week, one official spokesperson or the other (be it the Finance Minister, the Finance Secretary, the Deputy Chairman of the Planning Commission or the ubiquitous head of the Prime Minister's Economic Advisory Council) has declared that inflation is bound to moderate, in a voice tinged with surprise that it has not done so earlier.

This expectation came from a particular reading of the situation. Whenever prices rose rapidly, they were attributed either to supply-side factors, such as a poor crop, or to unavoidable factors, such as the base effect. (The base effect is the impact the previous year's level of prices has on the computed rate of inflation: if prices were low, the inflation rate or percentage increase in prices would turn out high even though the price level may not be too high.) Thus, when the Prime Minister spoke in February last year he looked forward to a good monsoon and a better crop. And, if prices had been unusually low a year earlier, even a return to normalcy would reflect a high rate of inflation that must be discounted. Occasionally, of course, there was talk of hoarding and speculation, but only on the part of unscrupulous traders who were exploiting temporary demand-supply imbalances.

Experience has shown that these beliefs were patently false. Despite the fact that the monsoon has been much better in recent seasons, the annual point-to-point inflation in the wholesale price index (WPI) for food articles stood at 18.32 per cent and 16.91 per cent during the weeks ending December 25, 2010, and January 1, 2011, respectively. The figures for the corresponding weeks of the previous year were 19.9 per cent and 19.6 per cent respectively. Not much has changed even though the commodities involved are slightly different.

Moreover, the month-on-month inflation rate as reflected even by the WPI for all commodities, which stood at a disconcertingly high level in the first half of 2008 and declined consistently between July 2008 and July 2009 and accelerated subsequently, has remained at high levels throughout 2010. The month-on-month rate of inflation stood at 9.7 per cent in November and 8.5 per cent in December. And if weekly WPI movements are an indication, this is likely to be true in January 2011 as well.

The consumer price indices for agricultural labourers and industrial workers, which reflect the movements in the basket of goods consumed by these sections (which includes housing that dampens the increase), also rose by 7.1 per cent and 8.3 per cent respectively in November relative to the corresponding month of the previous year.

This persistence of the inflationary trend is substantially because the government, while occasionally expressing concern over the high level of inflation, has done little to combat it given its belief that inflation will necessarily moderate when supply conditions improve or the base effect wears out. This has sent out the message that economic governance under a government populated with economists of repute has broken down. That impression has only been bolstered by the open spats between segments of the government over who is responsible for the persisting inflation.

To understand the factors that could be driving the price rise, we need to turn to a number of noteworthy features of the current inflation scenario. The first is that while it is not restricted to food, it has been driven substantially by food articles that are more prone to speculative influences. In the case of these commodities, even when demand-supply imbalances are minor or absent, speculation can push up prices.

The second is that within food articles, inflation has, at different points in time, affected different commodities, such as cereals, pulses, vegetables, eggs, meat and milk. Not all of these commodities are equally weather dependent and the prices of some are influenced by where administered prices are set. To attribute the trends in their prices solely to demand-supply imbalances or imported inflation is to avoid the conundrum.

Third, when inflation does occur in some food items, be they onions, vegetables or even cereals, the rate of inflation tends to be extremely high, pointing to the role of speculation in driving prices in the short run. Finally, even when such influences are not at work there seem to be factors operative that keep the all commodities inflation rate high.

Structural factors

Even though it is still early to say, the trend over the last one and a half years suggests that there are structural factors at work that have set a higher floor to the inflation rate. They may be neutralised in the future but could well return to play a role subsequently. The government has recognised this structural inflationary tendency in a peculiar, in fact patently absurd, way. It attributes the inflation to the demand-side effects of high growth. If people are richer because of an 8-9 per cent growth rate, they are bound to demand more. Since supply does not adjust, prices are bound to rise.

There are many assumptions here. That when the gross domestic product (GDP) grows, those who need to buy and consume more cereals, pulses and vegetables garner a reasonable share of the benefits of that growth. Or that when GDP grows, such growth cannot occur in large measure in the commodity producing sectors, resulting in a widening gap between the demand for and supply of certain goods. That even though the high growth era began in 2004, it is only now that it has generated demand-supply imbalances. And that if there is indeed a supply-demand imbalance the government is unable, for whatever reason, to redress it by resorting to imports. Making such assumptions is not just wishful thinking, but avoiding the conundrum.

It is not that there are no demand-supply imbalances. India's growth has indeed been lopsided. As has been argued by perceptive analysts, India's high GDP growth was recorded in a period when the agricultural sector and a range of petty producers were experiencing a crisis, an aspect of which was the non-viability of crop production and, therefore, an extremely slow growth of agricultural output and GDP. At some point that long-term crisis was likely to result in an unsustainable demand-supply imbalance.

But there are two other factors that are structurally embedded in the economic environment generated by the government's neoliberal reform agenda adopted for two decades now. The first is a tendency where corporate consolidation in production and trade, decontrol that permits profiteering, a reduced role for public agencies and public sector firms and the withdrawal or curtailment of subsidies on a range of inputs have pushed up costs and prices (including administered prices) substantially. As some have argued, India is increasingly a high-input-price-and-high-output-price economy, with a rising floor for many prices.

The second is the role that speculation has to come to play, what with liberalised trade, the presence of large corporate players in the wholesale and retail trade, and the growing role of futures and derivatives trading in a host of commodities. Add the influence of these two factors to the underlying crisis in some commodity producing sectors and the long-term, structural inflation is more than partly explained.

The government, of course, does not consider these angles worth pursuing. The reason is partly ideological. It cannot bear anyone questioning the outcome of reform. It cannot bear the suggestion that corporate entry can lead to profiteering in a context of decontrol. It does not believe that speculation in futures markets can push up spot prices, and has banned some of these markets only because of public pressure. It cannot contemplate a larger role for the state and no role for corporate (domestic and foreign) players in both wholesale and retail trade. In the event, all that the Prime Minister's emergency meetings on the inflation issue have thrown up is an inter-ministerial group mandated to monitor short-term firefighting measures and promote actions that the government has for many years now claimed to be promoting.

To top it all, precisely at a time when it can come in handy, the government is threatening to renege on the UPA's promise to deliver universal access to a minimum quota of food through the public distribution system. Riding on the argument that not enough foodgrain is available, even though production has been good, stocks with the government are comfortable, and foreign exchange that can be used to import even more is being handed over to the rich to be transferred to accounts abroad, it has used the Prime Minister's Economic Advisory Council to stall even a diluted proposal from the Sonia Gandhi-led National Advisory Council to expand the public distribution system.

No guesses are needed to identify where the push for this effort to kill the proposal comes from. And here, too, the ultimate source is the neoliberal ideology that wants to cut expenditure and reduce the fiscal deficit even as tax concessions are handed out to the well-to-do.

The government is not alone in all this. There is an influential body of opinion, including in the mainstream media, that the inflation problem is the result of poor supply management that cannot, at low cost, mobilise and reach supplies from wherever it is available to wherever it is needed. This creates unnecessary shortages that push up prices and encourage speculation that aggravates the price increase. The solution, therefore, is corporate retailing services, including those that large transnational retail firms offer.

According to reports ( The Hindu, January 19, 2011), using inflation as the excuse, the Union Cabinet is about to consider a controversial proposal to permit 51 per cent foreign equity in multi-brand retailing. This argument, too, borders on the absurd. It ignores the fact that though India has until quite recently had no such retail trade structure there have been long periods when prices and inflation have been kept in control. It also ignores evidence from other contexts where such retail chains are active that the margin between prices paid to producers and charged to consumers tends to be high, buoyant and downward sticky.

Neoliberal thinking not only leads to policy paralysis and absurd reasoning. It also results in policy responses that are contrary to what is needed. Thus, in the midst of the current inflationary mess, on the basis of the liberalised pricing mechanism, the oil companies have been allowed to hike the price of petrol a second time in quick succession. Given the role of public sector firms here, nobody would believe that a nod from the government was not obtained before the hike. If balance has to be maintained, a hike in the price of diesel must follow.

This government may go in for that as well. Doing this to the prices of what are universal intermediates in the midst of an inflation emergency might be seen by some as madness. If the belief that people can be called upon to sacrifice real incomes because reform cannot be held back or reversed is a sign of madness, then possibly it is.

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