People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)


No. 16

April 27, 2008


Inflation: How Much And Why

C P Chandrasekhar

Inflation today is the country’s economic problem number one. It further squeezes the mass of workers and poor peasants who are at the margins of subsistence, forcing them to sell their meagre assets if any, increase their indebtedness, or just starve. Inflation also erodes the income of the middle classes and fixed income earners, demand from whom is crucial to sustaining the recent economic boom. Finally, inflation is affecting the costs of production of producers who have been benefiting from India’s recent success in global markets. In sum, inflation today threatens just not the livelihoods of the poor but the high growth that the government has been showcasing.

This widespread impact of the current inflation is because its incidence ranges across a wide range of commodities. Taking all commodities, the headline inflation rate, as measured by annual point-to-point increases in the Wholesale Price Index (WPI), has risen from less than 4 per cent at the end of the December 2007 to more than 7 per cent in the second half of March 2008. This increase can be traced to many sources. A little more than a quarter of the overall price increase has been on account of primary articles, especially cereals. Half of one quarter is due to the fuel subgroup influenced by upward adjustments in the prices of petroleum and petroleum products. And as much as 60 per cent is on account of increases in the prices of manufactures led by diverse commodities such as iron and steel (17 per cent) and edible oils (7.5 per cent).



It must be noted that going by historical experience a 7 per cent rate of aggregate inflation is by no means high. But it is because the current inflation affects a wide range of commodities and impacts on different sections of the population that the political fall-out for the government has been extremely adverse. This is also why the current inflation has received the attention it does even though the recent increase in prices in a sensitive area like food is less than what it was in recent history. Thus, if we go back a year, the inflation rate in the case of primary articles was even higher than now. The point-to-point annual inflation rate in the case of these commodities rose from a minimum of 8.8 per cent to 12.2 per cent during the first fifteen weeks of 2007, before declining to less than 4 per cent by the end of the year. As compared with that the primary articles inflation rate during the first fourteen weeks of 2008 fluctuated within a much lower range of between 3.9 and 9 per cent. If food price inflation is the only issue, things seem better for the government at present than they were a year back.

However, two other features draw attention to the current inflation in food prices. First, at the retail level, where the impact of inflation is actually felt, price increases in one or a few sensitive commodities, varying from edible oils to rice, have been particularly steep. In early April, for example, the average retail price of rice at centres across the country tracked by the ministry of consumer affairs had risen from Rs 12. 5 a kg to Rs 15.2 a kg or by 21.7 per cent relative to the corresponding date in previous year. This is a huge increase when compared with the 5.4 per cent rise registered in early April 2007 relative to the corresponding date in 2006.

Second, if we take a more medium term perspective retail prices of most primary articles have registered large increases in the recent past. Thus, if we consider increases in the retail prices of four food articles (rice, wheat, atta and gram) over the last year (ending April 4, 2008), they range between 4.2 per cent and 21.7 per cent. However, if we take a two year period ending April 4, 2008, the increases range between 21.1 and 29 per cent. That is the average annual price increase over the last two years has been more than 10 per cent in all four of these commodities. Short run inflation in individual commodities is more noticeable and damaging if it occurs in a context where prices across the board have been rising in the medium term. That does seem to be the case here.



Put these tendencies together and for some time now we have been in an inflationary environment that has not been adequately captured by annual point-to-point changes in the WPI. What factors account for this chronic inflationary tendency? There are two fundamentals that cannot be ignored. One is the much-recognised long-term neglect of agriculture, reflected in declining real investment, rising costs and inadequately remunerative prices. As a result, production has been falling short of requirements, with per capita foodgrains production having declined during the 1990s. The other fundamental is the increasing inability of the government to use the procurement and distribution mechanism as a means of controlling the domestic prices of cereals and pulses. The liberalisation of trade in many of these commodities has seen the entry of private traders including large transnational buyers, who have cornered stocks and limited procurement by government agencies like the Food Corporation of India. Though procurement in 2006-07 was, at 11.1 million tonnes, higher than the 9.2 million tonnes recorded in 2005-06, it was way below the levels of 16.8 and 14.8 million tonnes recorded in 2003-04 and 2004-05. Figures from the Food Corporation of India indicate that total procurement for the public distribution system has declined from 30 per cent of production during 2001-02 to 15 per cent in 2006-07.

Advocates of liberalisation would argue that this should not be a problem since the government can use the currently abundant foreign exchange reserves to import food and augment domestic supply. But the impact of such measures on producers would be damaging, as is visible in a state like Kerala which is experiencing the effects of cheap edible oil imports on the prices of coconut oil and coconuts. Imports supplied to the domestic market at low prices (sometimes using subsidies), displace domestic production and worsen food security. The task is not to displace domestic production, but strengthen it so as to enhance food security. If not India would be a chronic victim of fluctuations and shocks in global markets.



India is currently experiencing the effects of one such shock. In recent months, world food prices, especially those of staples like grains, have been rising sharply. Not all of this is because of demand-supply imbalances, but partly the result of commodity speculation. As a result, imports have been at prices much higher than that paid to domestic farmers, swelling the subsidy paid to cover the difference between the import price and the domestic sale price. It is clear that the government would find it difficult to justify the differential in prices paid to domestic and international producers. The resulting expectation that government would link domestic to international prices is encouraging domestic speculation that is seen as partly triggering the current inflation in food prices.

To food price inflation should be added the effects of upward adjustments in domestic oil prices to take account of the rise in oil prices in international markets. Oil products directly or indirectly enter the production of a wide range of commodities and services. So the effects of an increase in oil prices on the prices of other commodities would be substantial. There are, however, alternatives to rising oil prices. The petroleum sector contributes a huge share to the government’s indirect tax kitty. So the government could forego a part of its oil revenues by reducing indirect taxes and allowing oil companies to charge more without affecting retail prices. Unfortunately it has chosen not to do so.

Finally, liberalisation has meant that domestic prices tend to align with international prices not just in the case of products where part of supply is imported, but also in those where part of domestic production is exported. This is what has been happening in the case of commodities like iron and steel and other metals, in whose case international prices have been soaring because of increased demand especially from China. Indian firms participating in this international boom through rising exports at soaring prices are obviously adjusting or manipulating domestic prices upwards. This has forced the government not only to control the rise in prices but restrict exports. The hope that greater integration of Indian and global markets would benefit consumers and not producers has obviously been proved wrong by circumstances.

In sum, the current inflationary environment is the result of many factors. Agricultural inflation is partly the result of the agricultural slowdown resulting from reduced public investment in irrigation and lower development expenditures in the rural areas. It also is the outcome of the deregulation that has undermined the procurement and public distribution framework that provided remunerative prices to farmers while attempting to deliver food to consumers at reasonable prices. Oil price inflation is the result of the government’s belief that domestic oil prices must be directly aligned to international prices, without any changes in the duty structure that imposes a huge and rising burden on consumers. Finally, inflation in manufactured goods is the result of the liberalisation of trade and capital flows that has meant that India is no more insulated from international shocks, importing inflation and other crises from an unstable global economy.

Give the wide-ranging nature of the current inflation, the policies to counter it must be directed at its multifarious sources. But all of them would require reversing many elements of the liberalisation resorted to in recent years. The difficulty faced by the current government in combating inflation is that it is unwilling to come to terms with this reality.