ECONOMIC HIGHLIGHTS   

New Delhi, 21 May 2008

Inflation Still Untamed

RETHINK POLICY PEGGING RUPEE TO DOLLAR

By Dr. Vinod Mehta

Former Dir (Research) ICSSR

 The rate of inflation after having dipped to below 4 per cent surpassed the 5 per cent level in March and now for the week ending 3 May it moved to 7.83 per cent, touching a 44-month high.  The measures taken so far to control inflation have not yielded any results.

The Reserve Bank of India has raised the credit reserve ratio twice while the Finance Minister has reduced the import duties as well as imposed/increased the export duties on a few essential commodities. It is also persuading the steel and cement manufacturers not to increase their prices.  In spite of positive sounds that inflation will be controlled nothing is happening.

And now the Prime Minister has stated that it will come down by September this year. But fears are being expressed in certain quarters that the rate of inflation may become double digit in a few months.  The reason is that earlier the inflation was mainly due to a mismatch in the domestic demand and supply and now an international dimension has been added to it. Namely, the rising oil prices, shrinking supply of essential commodities internationally and the weakening of the US dollar are showing their impact.

In fact, inflation has suddenly spurted in many countries of the world and in some developing countries like Afghanistan, Bangladesh, Pakistan, Indonesia, Philippines, Tajikistan etc. Besides, the increase in the prices of essential commodities have been very high. With food and fuel prices soaring, inflation topped 8 per cent in the Philippines and 9 per cent in Indonesia. Even Japan, which suffered nearly a decade of deflation, last month reported that inflation hit a decade-high. Oil rich countries of West Asia too like Egypt and Jordan are unable to explain the unprecedented increase in the prices of essential commodities to their citizens.

Apart from India other BRIC (Brazil-Russia-India-China) countries are also facing the menace of inflation.  Compared to Russia, India and China the rate of inflation in Brazil is less at 4.8 per cent but it is increasing.  However, the rate of inflation in Russia is above 7 per cent and in China about 8.5 per cent, way above India. China's recent bout of inflation has been triggered mainly by soaring food prices. The overall food prices have increased by 22.1 per cent in April from a year earlier, “while pork, the favorite meat for the vast majority of Chinese, became 68.3 per cent more expensive over the same period.”

Inflation is, thus, a worldwide phenomenon today but for India the increase in prices have come at a time when there has been some slowdown in the growth of the domestic manufacturing sector and the fear of worldwide recession especially in the US which may affect our exports and indirectly affect the growth of the economy in general.

This is indeed, a very difficult situation for the Government in power especially when the elections are due both in the States as well as at the Centre.  If the choice is between growth and inflation, it makes sense to choose growth and ignore inflation, which can be tackled through short term measures like imports in weeks or months.

But if we lose the growth momentum it will take years to get back that momentum.  It has taken almost 50 years to raise the growth rate by nearly three times from almost three per cent (the so called Hindu rate of growth) to nine per cent today. But with the inflation rising above 7 per cent there is a likelyhood  that some growth will be sacrificed to tame inflation since untamed inflation is a politically hot potato.

It is common knowledge that inflation strains family budgets with more or less fixed incomes and erodes their real incomes. While higher growth impacts the whole economy bringing in more revenues to the Government and leads to creation of more productive assets and more jobs.  An ideal situation is one where the growth rate is higher and the rate of inflation is modest.  In real life we seldom get such ideal situations.  The Government’s of the day have no option but to manage the situations with the options available to them at that particular point of time.

But as every one knows there is no magic wand to control or bring down the rate of inflation overnight as the people would like it to be.  There is always a time lag. Steps taken now will have the desired effect a month, two months or even three to four months later.  And in certain situations it may take a few years as in the case of agro-based essential commodities.

The main reason for the increase in the price level is the mismatch between the demand and supply of essential commodities. This mismatch has not occurred overnight but has been gradually developing for the past few years.  For instance, the acreage under food crops has been shrinking, productivity of agricultural crops is stagnant and there is still no freer movement of agricultural products within the country.

In short, nothing has been done to increase the supply of essential commodities. And the supplies cannot be increased overnight to control inflation.  The Government will have to take certain decisions now so that the prices of essential commodities remain relatively stable over a longer period of time.

This calls for large investments in the agricultural sector and rural infrastructure.  This also calls for raising the agricultural productivity by providing farmers with improved seeds and other inputs, timely credit, chain of cold storages, market information and so on.  A large number of volumes have been written on this aspect in the past 50 years but the need is to implement them.  Can one ask if there is any blue print for this?

Another reason for inflation in India is that the rupee is pegged to the US dollar and the dollar’s weakening worsens it.  To quote from a US financial paper : “The weakening U.S. dollar is another source. Not only is it pushing up prices of American imports, it is transmitting inflation to the dozens of economies that link their currencies to the U.S. dollar, from Saudi Arabia to Hong Kong to Mongolia. Because of their currency pegs, these economies are forced to track Fed rate cuts even if they aren't facing recession.

“Isn't that strange that in every country pegged to our dollar, when the Fed floods the system with liquidity,  every country tied to us gets more inflation, but we do not? Almost ironic isn't it, but I trust the Government reports --- and if they say no inflation --- then no inflation it is!

 “In China we are now seeing nearly 9 per cent inflation. In India, white collar wage inflation is sometimes in the 20%+ range. Most of South America has Central Banks raising rates to try to fight inflation, as is Australia. It appears America, Canada, and Antarctica are immune to the scourge - no inflation zones!”

It is high time that we rethink our policy of pegging the rupee to the US dollar.  There have been suggestions that we should link the rupee to a basket of currencies say, the Euro, Japanese Yen and US dollar.  But for that we will have to make changes in the RBI rules.  May be the RBI can enlighten us on this? --- INFA

(Copyright India News & Feature Alliance)