Where are prices going from here? Financial Express Feb 19, 20

Inflation this year has been the most difficult variable to interpret for three reasons. The first is the issue of a statistical base year effect, which has often not shown a high number even when prices were rising. The second is that prices are always defined at points in time that have been volatile over weeks, rising and falling alternately, thus giving confusing signals. The third is that there is the reality of the marketplace where we continue to pay high prices even as we are told that prices are coming down. What is the right picture going forward? The CPI indices for December show some shocking numbers that are generally out of the purview of public discussion. The CPI for industrial workers shows an increase of 15%, for agricultural labourers 17.2% and rural labourers 17%. The WPI for January at 8.56% reflects only a part of this. The problem with the inflation numbers is that they are calculated over previous year’s indices. There is a statistical bias that will be imparted to the fuel and manufactured products’ indices in the coming months. The fuel numbers were benign till May 2009 and manufactured products till August 2009, which means that there will be an upward thrust statistically. Unless prices actually decline, we will end up with higher price indices for these two sets of products, which account for 78% of the WPI. Primary products started showing an increase in March 2009, which, if one recollects, did lead to a situation in June 2009 when there was a debate on deflation as the WPI turned negative. These statistical mirages will continue to cloud our judgement on account of base year effects. What about signs of lower food prices being witnessed today? Here one must realise that we have two seasons in agriculture—kharif and rabi. If the kharif crop is unsatisfactory, then we have to live with lower output unless we supplement the supplies through imports. We are trying to do so with pulses and sugar, and to an extent have reined in prices. If the crop has a good rabi season, then there can be compensation in output and hence prices can decrease. But crops like tur, soybean and moong are primarily kharif and a shortfall will remain till the next harvest. Therefore, even though we are expecting an excellent wheat WPI may come down, we will continue with higher prices for other products. Further, the government’s own actions have propped up food prices through the MSP—the government, in its quest to build up stocks, hiked the price of rice and wheat to higher levels which, some critics feel, was not justified. Therefore, even a bumper crop may not mean lower prices if the MSP is higher.
So far, all the inflation talk has been on the supply side, but what about demand? There are signs that the economy may be heating up as evidenced by the very high IIP growth numbers (though understandably the low base has again contributed to part of this spectacular IIP growth). A fast-growing economy generates demand-pull pressures as there is an increased demand for manufactured products, in particular, as investment and production accelerates. This, in turn, puts pressure on industries such as machinery, metals, chemicals, cement, fibres and so on. Therefore, while on the supply side we can be optimistic that output will improve when the crops are harvested, there is a question mark when it comes to demand-pull inflation. Globally, it has been observed that while agricultural product prices have been benign (barring sugar), those of metals have started moving upwards, ostensibly on the saddle of the growth process that has picked up not just in China but also in the US and the Euro region. This has meant that there is greater demand for associated products, which will put some pressure on prices going ahead as there are always lags before capacities are created which result in output. Finally, the oil factor remains an enigma to us today, as one can never really guess which way it would move. While this would have been less serious in an administered pricing regime, if the recommendations of the Kirit Parikh Committee Report are accepted, there is a feeling that higher retail prices for oil products may fuel inflation. While it would be outrageously bold to take segmental calls within the WPI, notwithstanding the base year effects, inflation will be a concern in 2010-11. While the current levels of double-digit rates may not persist, a high single-digit number does not seem out of place if oil reforms and industrial growth take off.