It
doesn't take much to sniff out this one. Prices of everyday items
such as fruits and vegetables and wheat have turned dearer; fuel,
of course, only seems to get more and more expensive and, assuredly,
the worst isn't over yet; and now, your monthly housing loan repayments
have gone up too, thanks to a hike in lending rates by most banks.
The inflation numbers say it all: The Wholesale Price Index (WPI),
more watched because it has a larger number of items in the inflation
basket and is updated every week, is inching up. In the 12 months
to August 12, the WPI rose 4.92 per cent, higher than forecast
and higher than the previous week's annual rate of 4.82 per cent.
(The following week, it fell, but a negligible 0.01 percentage
point). In the corresponding period the previous year, the figure
was 3.7 per cent.
To middle-class India, living on a fixed
monthly salary, that's bad news. But like an unattended common
cold that can turn into a life threatening infection, high inflation
can not just derail household budgets, but the overall economy.
The good news: Far from leaving it unaddressed, the government
has taken steps to check inflation-from reducing taxes on commodities
of mass consumption to keeping a check on the interest rates (lest
industry and retail consumers decide to cool off; see Friendly
Interventions). For instance, the government recently cut import
duty on wheat, and has asked banks to ensure liquidity in the
market to ensure that interest rates don't rise further. "Hardening
of global interest rates is not in our control, (but) what we
are doing is to ensure ample liquidity so that the impact of hardening
interest rates is softened," Finance Minister P. Chidambaram
told reporters recently.
The million-dollar question, however, is
this: Are these measures appropriate and enough or does more need
to be done to ensure that high inflation doesn't choke economic
growth? After all, inflation is a symptom, a response to supply
issues, demand constraints or supply chain mismanagement. The
political overtones of supply issues have never been underestimated.
For example, the BJP-led state government in Delhi was voted out
of power when onion prices shot through the roof in 1998 and became
an election issue. Rising input costs for industry can slow down
growth in the economy, since companies will find it hard to absorb
costs, and passing the buck to the consumer will end up making
goods and services more expensive and, hence, affect demand.
Friendly Interventions |
JUNE 8: Reverse repo rate raised by
RBI by 25 basis points
JUNE 28: Import duty on wheat slashed from 50%
to 5% for private importers
JULY 3: Ban imposed on export of sugar till March
31, 2007
AUG. 25: States allowed to restrict stocks of wheat and
pulses
|
On the demand side, when there is cheap capital
available in the market, profligacy kicks in with different segments
of consumers. Retail consumers shop till they drop, collectively
ramping up prices that kick up inflationary forces. Industry,
meanwhile, embarks on an expansion spree, hoping the bullish sentiment
will not lose steam and the incremental produce will find buyers
when it hits the market. Evidently, what matters really is not
inflation but the sentiment that it brings along. After all, inflation
affects different classes of society in different ways.
BT takes a look at some of these issues,
and brings out the nuances of the simmering inflationary forces.
Cost Push
The last time India imported wheat was eight
years ago. This year, imports are expected to be as high as 5
million tonnes, a little less than a 10th of our production. With
global wheat prices ruling at double that of two years ago, it
is not surprising that the WPI of wheat has risen 10 per cent
in the last year. As a consequence, farmers growing wheat are
the only ones insulated from this inflationary measure. The trend
is not limited to wheat. The same holds true for pulses and palm
oil, where prices have risen sharply. Not surprisingly, the Consumer
Price Index (CPI)-it reflects retail prices, but not very accurately-for
the agricultural workers has nearly doubled over the year. Since
urban rather than rural spending has been driving growth, India's
overall growth is unlikely to suffer significantly on this count,
argue economists. "The effects of inflation on the rural
sector will take some time to surface," points out Rajesh
Shukla, Chief Economist, NCAER, an economic think-tank.
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High inflation: Can derail
household budgets and the overall economy |
However, fact remains that the issue is accentuated
by the government's inefficient public procurement system, compounded
by constant alterations in the import policies for commodities.
"There are supply chain issues that squarely land in the
court of the agriculture sector. That, to my mind, is the immediate
problem that the government needs to tackle," says Govind
Rao, Director, National Institute of Public Finance and Policy
(NIPFP), and a member of the Prime Minister's Economic Advisory
Council. "There has been a shortfall in domestic supplies
due to demand as well as hardening of international prices. We
have taken steps to augment domestic supplies," contends
Union Agriculture Minister, Sharad Pawar.
As much as fuel for the human body has become
dearer, so has that for machines. Given that we import over 70
per cent of our crude oil requirements, the impact on the economy
is significant. However, much of the impact is absorbed by the
government and the public sector oil companies, since retail price
of close to 60 per cent of the products (petrol, diesel, LPG and
kerosene) are controlled. So, how fat is the bill? It is estimated
that a $10 (Rs 470) per barrel rise in crude oil-the increase
till date over the previous year's level-will result in an additional
payout of Rs 35,000 crore for the economy. Of this, the industry
will shoulder around Rs 15,000 crore. "Domestic industry
has been able to absorb this cost through efficiency gains, increase
in scales owing to growth, and intelligent substitutions wherever
possible," says Ajit Ranade, Chief Economist at Mumbai-based
Adiya Birla Group.
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"The real worry
for industry is the
possibility of demand sagging"
R. Seshasayee President/CII |
"Our advice to
banks was meant to ensure industries got competitive credit"
Ashok Lahiri
Chief Economic Advisor/Fin. Min. |
Furthermore, the robust growth in exports
(at an average 20 per cent over the last four years), on the back
of sustained global demand, offers a firm cushion against the
dampening effects of inflation. The sharp decline of the rupee
vis-à-vis the dollar in the recent past (during April-July,
the rupee declined by almost 5 per cent) has only improved the
export prospects, which grew by as much as 30 per cent last year.
Says Jitender Balakrishnan, Deputy Managing Director, IDBI Bank:
"Inflation is currently below 6 per cent and I don't think
it will go up substantially. Of course, oil prices have been increasing
and media reports have suggested that oil may even touch $100
(Rs 4,700) per barrel."
While public sector oil companies have significantly
shouldered the burden of high oil prices, fears of an imminent
retail price hike have kept the pressure on domestic interest
rates. Interestingly, on this front, the government and the RBI
have been pulling in opposite directions. The RBI has raised the
reverse repo rate (the rate at which it sells its securities to
banks, thus sucking out money from the system), signalling a higher
interest rate regime. Since a lot of money is chasing a handful
of assets, a higher interest rate will deter a rise in the flow
and keep inflation at bay. The Finance Ministry, in contrast,
has tried to hold on to lower interest rates through its role
as the owner of public sector banks, fearing that the prevailing
consumption-led growth, especially in the retail consumer segment,
will suffer if interest rates were raised.
Dearer Credit
A clear indication of the growing strain
on the banking system is the fact that the credit to deposit ratio
for banks has reached new highs (that is, there is greater credit
offtake) while the investment to deposit ratio, which is reflective
of the investment in government securities (that goes towards
funding the fiscal deficit) has been dropping. Says Ashok Lahiri,
Chief Economic Advisor, Finance Ministry: "The recent surge
in the inflation rate has been on account of the rise in prices
of primary products (wheat, sugar and pulses). Clearly, this is
a supply-chain issue. As regards the Finance Ministry's move to
advise public sector banks (in the back drop of RBI raising the
reverse repo rate), it was aimed at ensuring that credit to productive
industries is not affected." While this argument wears thin
when it comes to the issue of preserving the autonomy of commercial
banks, there is also a fundamental debate on whether the intervention,
if at all required, was premature. Monetary theorists argue that
the first time that supply-led inflation occurs, the government
should not intervene. It is only the second time around that intervention
should be made.
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"At the end of the day,
demand management is key to handling inflation"
S. Chaudhuri Chief Economist/ ICRA |
"We have taken steps
to hike domestic supplies of wheat and pulses"
Sharad Pawar
Union Agriculture Minister |
Meanwhile, is the case of a supply-led inflation
overstated? "At the end of the day, demand management is
key to handling inflation," says Saumitra Chaudhuri, Chief
Economist, ICRA, and a member of the Prime Minister's Economic
Advisory Council. "There is obviously a demand issue that
is intrinsic to the rising inflation rate, especially, when we
look at the increasing money supply in the system. Further, we
need to remember that as we integrate with the Asian economies,
inflation needs to be well below the projected 5 per cent mark,"
he notes.
Evidently, industry is not exactly complaining
right now. Says President of industry association, CII, and Managing
Director of Ashok Leyland, R. Seshasayee: "Industry margins
are indeed under pressure due to inflation and this cannot be
made good by efficiency measures. However, the prevailing pace
of economic growth has ensured that the overall profitability
has not been affected." The real worry for industry, he adds,
is the possibility of demand sagging due to the negative sentiment
on inflation. "So far, this has not happened, but the fears
are entirely justified," he cautions.
While the prices of industrial input commodities
have risen sharply in the recent past, the fear of inflation is
more due to the rise in agriculture commodity prices. Sure, government
interventions have provided some relief, but there is far more
that can be done, given the shoddy state procurement and pricing
system. Signs of activity are visible as the private sector is
slowly nudging its way into organised farm retail, where huge
efficiencies are waiting to be reaped. Until organised retail-like
in the US, where Wal-Mart is credited with single-handedly keeping
costs down-significantly increases its share of 3 per cent, supply
chain inefficiencies will continue to add to the cost. And the
RBI and the government will have to continue walking the fine
line between credit-led growth and inflation.
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