The inflation delusion and why prices won’t come down soon:DNA 30th August 2010

Inflation has become an eyesore today because, frankly, we do not know what to do about it. We all know there is a problem which has to be solved; but there seem to be no fixes here.

As a policy maker, one is staring hard at the WPI indices hoping that the high numbers of yesteryear will help lower the numbers this year. As we try nervously to assure one another that all will be right soon, there are several myths that need to be addressed.

The first is that inflation will come down. If you are an economist; you attribute a number to it and arrive at 6% by December or March. Is there a rationale for the same? Honestly, there is none except that we all know that the prices kept zooming last year from September
If we paid Rs95 for tur dal last November, it will come down to Rs70, which means that prices have crashed. Never mind that they were Rs49 a kg in January, 2009, when prices moved up despite us being told that production was higher.

The second is that the government has lots of food stocks. Presently there is considerable quibbling about how stocks are rotting in the open and are even unfit for cattle. Others are arguing that offloading the same will cost money which will inflate the fiscal deficit. One forgets that the government only stocks rice and wheat where prices have increased by Rs2-3 kg in the last 18 months.

The government does not stock sugar, pulses, milk, poultry, coarse cereals, edible oils, etc. These are the prices that have increased substantially by between 30-100% since January, 2009. Hence talking of food stocks is only a weak diversion and is not quite reassuring.

The third is that in the present situation things will improve soon. But, the reality is that nothing can happen on the price front until harvest time. Crops are harvested in October and April onwards for the kharif and rabi seasons. Once the crop is in short supply, we have to live with the same till the next season. It cannot be replenished unless we have buffer stocks or import the same.

If there are no stocks (pulses, sugar) or if they can be imported only at a higher price, then imported inflation will ensue. Similarly, once the price of fodder increases, milk prices will move to a new high. The WPI is an index consisting of several products. While the WPI may come down, food prices cannot. The assurance that inflation will touch 6% is meaningless when we pay more for our vegetables at the market place.

The fourth myth is that prices will come down at the time of harvest. Anecdotal evidence shows that prices are not mean-reverting once they increase. A new high is always established, which becomes an average threshold for the future. Hence we should not expect tur dal to come back to Rs40 per kg times, and should be content to buy the same at a higher price.

The fifth myth spoken of is that the RBI can bring down prices. While the RBI has to increase rates to combat inflation, monetary policy cannot enhance supplies. It can control the supply of money which lowers demand for goods and hence prices. But that takes two-four months to work. If there are shortages, then we have to live with them and pay higher prices for these products. Higher interest rates only help us earn more on our deposits which gives an illusion that inflation is being controlled.

The sixth view is sympathetic to a government which is trying hard but is a helpless spectator. The government has contributed to inflation by increasing the minimum support prices of commodities (MSP) over a period of time. The MSP is the price offered by the government to farmers which is announced at the time of sowing. While it is effective in terms of procurement of wheat and rice, it increases the base price of crops for consumers.

These prices have almost doubled across all cereals and pulses in the last five years and hence the government cannot exculpate itself from this current trend of high prices. The choice is between consumers paying more and farmers receiving higher incomes.

The last facet of inflation justifies the hike in petro-product prices on grounds that the deficit needs to be reduced and it is only those who drive Mercedes cars who would be affected. While fiscal austerity cannot be challenged, increasing petroleum product prices at a time of high inflation is a recipe for even higher inflation as it feeds into our travel costs and transport costs of all goods.

Hence, practically speaking, we have to live with higher levels of prices and should interpret the WPI numbers with the proverbial portions of salt!