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Friday, January 1, 2010

Inflation: What’s in Store for 2010?

As the year is drawing closer to its end, thanks to the skyrocketing food-prices, the Wholesale Price Index-based inflation has shot up from 1.34%, as at the end of October, to 4.78% by the last week of November—three-and-a-half times’ rise in just a month. The monthly data released on December 14 reveals that in the fourth week of November food inflation had shot up by 19.04%, the highest in over a decade. But for the prices of edible oil, which had, however, turned cheaper, the prices of every other food item had gone up. Obviously, it is no wonder that the rise is more evident in the Consumer Price Index—which is well above 11%, for greater weightage is given to food items in CPI than in the WPI. As usual, the government agencies have expressed their concern over rising prices, and also assured the hard-hit bottom of the pyramid that necessary action to contain it is a foot.

But the big question is: What caused the current spike in inflation? And the answer is pretty disturbing, for the spiraling food prices are more due to supply constraint. The Economist’s index of food prices indicates that the global food prices have gone up 18.3% over the last 12 months. It therefore means that the rise in food prices is not a mere local problem. That aside, there was a fall of 1.6% in our food grain production during 2008-09. Again in the current year, due to the late start of monsoon, and drought and floods in certain pockets, food production is estimated to fall by another 2%. All this is sure to impact the food security of the poorer section of the society, as according to the Tendulkar panel report, poverty has already increased by 10% from 27% to 37%. Standing at 42%, poverty is much worse in rural India. Of course, besides supply-side constraints, food prices are also impacted by trade policies, government intervention, market fragmentation, tacit manipulation of prices by the market intermediaries, etc. Either way, arresting the price rise in food products has thus assumed greater significance.

The other important development that needs to be borne in mind is: y-o-y manufactured products inflation is subdued at 3.99% and fuel inflation continues to be negative (-0.89%). But a weak base and the continued rise in food prices owing to supply-side shocks are, cumulatively, quite likely to push the inflation beyond the RBI’s forecasted inflation rate of 6% by March 2010, that too, well before that period. If such expectations are strong and persistent, there is scope for second round effects on general inflation to emanate, particularly, under easy monetary conditions such as what are prevailing today.

This has obviously triggered a debate for the RBI to raise interest rates for controlling the inflation. But such enthusiasts for monetary tightening must bear in mind that there is hardly any linkage in India between food inflation and general inflation, for the wages of a large chunk of population are not indexed to inflation. Yes, tightening of monetary policies are effective in addressing the second-round effects of food-price rise, but certainly cannot bring down the food prices.

The immediate answer for the current spiraling of food prices is therefore improving their supply through imports and arresting the speculative tendencies of the market intermediaries. Here again, easing of trade policies and the resulting import of food products through market intermediaries may not yield the desired results, for most of the importers of food products being active in domestic market have least interest in deflating the prices. So, import through state agencies is the best alternative, provided they are managed transparently and with business acumen. In the long run, the only way for stabilizing food prices is to augment agricultural production in the country. As the visiting president of the International Fund for Agricultural Development observed, our food-inflation is fueled by a web of complex challenges: rising population, growing prosperity and the accompanying change in dietary habits of the populace, and climate change. These problems can be addressed only through adoption of new technology for modernizing farming, which means more agricultural investment.

Again that in itself may not be sufficient, for to get the response to increased demand for food products translated into increased output calls for a functional market mechanism for a meaningful interaction of these forces. But in reality what we have are: poor rural infrastructure and an overly, that too wrongly, regulated market. In view of these ground realities, we must at least, as Nuwanze advocated, set aside 15% of our annual budget for agriculture and development of rural infrastructure, such as rural roads, electrification, irrigation and creation of storage capacities. Simultaneously, the government must ensure timely availability of credit for farming.

Importantly, the government must, at the same time, create competition in the domestic food market by encouraging market integration across the supply chain via participation of big players, of course, duly supervised by the state intelligently.

That’s the only way to fight against the food-prices-driven-inflation. Instead, if the authorities choose to tighten the monetary conditions, it may dampen the growth prospects that have just picked up momentum after being beaten by the recent global financial crisis, and in turn prove suicidal. So, what is needed to temper the inflationary expectations is a close watch on growth momentum and judicious timing of gradual withdrawal of the monetary and fiscal easing that is currently in operation. 

                                                                                                             - GRK Murty


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