The Inflation Delusion: 12th January 2011: Financial Express

The course of inflation and the official response this year has been quite interesting, as it has been iced with optimism. After being in denial mode for almost 4 months, with the standard response being that inflation will come down to 5% by March, we do realise today that this will not be so. The feeling was that over a high base of last year, the number had to come down, which has not happened and food inflation is ominously in the double-digit range. Now, one is looking at 6-7%.

Some of the myths that have been busted about inflation can be put into perspective. The first reassurance was that we had large stocks of foodgrains with the FCI. Debates ranged on how to get these grains to the poor and the damaged grains in the warehouses added to the decibel levels of discussions. But, FCI holds on to only rice and wheat and, hence, can theoretically influence only their prices. The lesson learnt is that we should not get carried away by this fact as rice and wheat account for around 3.5% of the weight in WPI and there are other components that can jack up the inflation rate.

The second comfort provided was that the kharif production would be higher and, hence, prices would come down from October onwards. While the first advance estimates are sanguine, the point missed is that we have only been brought back to the pre-drought levels. Further, while these products have not displayed a significant increase in prices, other components continued to increase, thus making the inflation number nasty. The clue here is that we clearly need to look beyond the usual staples of cereals, pulses and oilseeds when viewing food inflation.

The third factor in the sidelines was the high MSPs announced, which have ranged from 5% to 30% for various crops and which has increased market benchmarks. While most MSPs are not actually used by farmers, as market prices are higher, there has been an inherent upward thrust to the prices. We really need to revisit this policy of MSPs, as it has been taken to be a panacea for our farm problems. By announcing higher prices, it is hoped that production will increase, which has not always happened. In fact, such high MSPs have tended to divert land from other crops to rice and wheat, where the returns are better and assured. Therefore, MSPs have distorted the cropping pattern as well as imparted an upward thrust to prices. This is a difficult decision to take because higher MSPs give farmers the benefit (to the extent that it does not go to the adathiya), but also add to the woes of the consumer and RBI.

Now, higher prices of food products have tended to become a structural problem and get built into the costing for farmers. With unchanged productivity and land under cultivation, the only way a farmer can protect his income is by increasing prices, which increases cost for users—especially of dairy and poultry. The cost of animal feed has increased due to the drought last year, which has pushed up the final prices. Today, this category, along with the fall in production of vegetables and fruits, has increased prices. Hence, we have a situation of robust kharif production and higher inflation in other products.

The fourth diversion has been the RBI increasing interest rates. But, can higher rates augment production? Certainly not, and while interest rate hikes are necessary to protect savings and address inflationary expectations, they cannot make up for shortages in supplies.

Quite curiously, the government has decided not to increase diesel prices this time as inflation is high. This is an interesting statement because earlier in 2010 when diesel prices were increased, we were reassured that such an increase would have no impact on inflation. What is one to make of it?

Are there any solutions? The answer is actually a confident ‘no’ in the short run, because the solution is to augment supplies, which can only happen in the medium term. Clearly, this issue has to be addressed, speaking literally, at the ground level, and the government has to take the lead here. Farming is no longer attractive and the private sector’s indulgence is restricted to its own activity in the retail segment.

A way out would be to use the funds that are allocated under the MGNREGA programme to actually work on making land fertile and grow crops, which will make the scheme more useful and go beyond a pure dole system, which is what it is today. Modalities can be worked out on using probably a cooperative approach here so that the farmers can also draw benefits from the profits made through such cultivation.