Indian Talent, Global Content
|
Indian Talent, Global Content |
New and Improved: May 2012
Just Launched - New eStore selling travel guides, editing courses, ebooks and special offers |
Inflation: Why & How
December 2007: Inflation under control at 3.6%, well below RBI’s long term target of 5%. What has caused this surge? A lot of answers would come to the mind – rise in oil prices, government’s inability to control price rise, depreciating rupee, surge in import requirements, and even high liquidity. But actually, no one is really sure and hence the ineffectiveness of measures being taken to control it. Let’s examine these reasons one by one. A lot of people keep saying that the oil prices are the major cause of inflation. Globally, yes! The high inflation around the world is attributable to a large extent to increasing energy prices. But in India’s case, the rise in import prices of oil had not really been passed to the consumers until June. Then what explains the inflation of 8.75% before the week the petrol & diesel prices were hiked. Partially, oil prices were responsible as Aviation Turbine Fuel (ATF) price was being continually hiked and this might have translated to a little increase in transportation cost for few commodities. But, this would have only a negligible effect and it can in no way be construed as a major reason for the high inflation. Government has been continuously blamed for its inability to control prices to the extent that people have started withdrawing support from the government. While it is the duty of any government to protect the poor from any rise in prices, but the government, due to unavoidable international circumstances and internal pressures, is not always in the driver’s seat to control inflation. How do you expect the government, who is being forced to open up the economy continually by industry lobbies, to stop increase in prices due to global convergence of prices at the same time? The criticism of the government seems to be more of a political agenda rather than a justified accusation. The rupee, which had risen to Rs. 39.30/$ levels last year, has again depreciated to Rs.42.80/$ currently.
This has been caused largely due to political instability and fears of slowdown in the economy resulting in withdrawal of investment by FIIs. While this has helped India on the balance of trade front by benefiting exporters, it has also made imports dearer. Considering India’s import basket which primarily consists of goods not so price-sensitive, increased prices of these imports have been partially responsible for this inflation. Thus, depreciation in rupee is a partial contributor to inflation. Another argument given for increase in prices is the increasing dependence on imports. Due to the rapid growth the economy, the demand in the economy has grown. To meet this demand, import demand has gone up as domestic capacity is insufficient to meet this demand (or at least it is so believed). However, barring oil and few food items, imports do not constitute a major part of the basic food basket of Indian population. Hence, imports do not really justify an increase in inflation. High liquidity seems to be a valid reason prima facie as Indian interest rates have been quite high for some time while the Fed has been cutting rates over the past few months to counter a recession in its economy. The interest rate differential had caused FIIs to invest in India which led to rupee appreciation. Exporters forced RBI to control appreciation for which it bought dollars and infused liquidity in the economy. However, if we look at the current scenario, we observe that the inflation is a cost-push inflation and not a demand-pull inflation caused by high liquidity. This is clearly visible from the fact that RBI’s recent CRR and repo rate hike did not have any major impact on inflation. Thus, so far we have not arrived at any definitive reason for inflation. Thus, let us now analyse the causes of inflation category-wise. The composition of WPI is given below:
Globally, the inflation has been caused due to rise in food and energy (which together account for over 40% of WPI) prices, which is true in India’s case also: Food articles, both primary and manufactured, constitute about 26% of WPI. Food prices in India have risen because of two major factors. One is that due to allowing of trading of commodities on exchanges and globalization, global food prices are moving towards convergence. Food prices elsewhere in the world are higher because of the subsidized PDS system in India and thus, convergence means increase in domestic prices and hence inflation. Secondly, certain items like edible oils are imported in big quantities and thus, rupee depreciation recently led to increase in import prices. This is the primary reason why inflation initially surged to the 7-8% levels. Energy prices, which vary directly with fuel costs or more precisely, oil costs, are rising fast. Oil prices have increased fro $65/bbl to about $140/bbl. This has percolated to consumers in the form of the recent price hike of Petrol, Diesel and LPG prices which caused inflation to reach double digits. Besides, as explained earlier, it has also led to increase in transportation costs through airlines. Most people argue that supply tactics by OPEC as well as increase in demand are responsible for this. However, little does everyone know that Saudi Arabia, world’s largest exporter of oil has been continuously increasing output for past three months. As far as demand is concerned, it surely has not risen so much as to cause the prices to double. The real reason behind the oil price rise is speculative trading by financial market participants and not supply-demand factors. Crude oil, being a commodity tradable on exchanges, has been subject to speculation by huge financial players to earn short-term profits. This has caused prices to skyrocket due to baseless rumors and sentiment. Having arrived at the cause for spiraling prices, it has to be determined why the government has been unable to ease it. The RBI has raised CRR from 5% in to 8.25% in past six months and also hiked repo rate by one percentage point. This flushed liquidity out of the market and also made borrowing dearer. Lesser liquidity and dearer funds decreased demand in the economy but this was ineffective because as already discussed, this is more of a cost-push inflation than a demand-pull inflation and hence demand side measures are not the solution to the problem. One solution from the Indian government to contain oil prices seems quite apt. It suggested to the international community that oil prices be maintained within a band where consumers ensure that the price does not fall below a limit and producers ensure that it does not rise above the upper limit. The market forces shall determine the prices within the band and speculative trading would be restricted as the price cannot rise or fall beyond a limit. Besides, India should start looking for alternative energy sources and the N-deal, if signed, could go a long way in helping this cause. As far as the food prices in India are concerned, a good monsoon would definitely help the cause and the situation so far does reflect a good picture ahead for monsoons. Rain gods have been very generous on India so far this year and if this continues, farmers shall reap a good harvest and food prices should come down. There is a small group of people saying that containing inflation is not only unnecessary but also undesirable due to the sacrifice ratio (the sacrifice of output in %age terms to contain inflation by one percent) of India being two. This translates into output losses of about Rs.1,00,000 crore to decrease inflation by two percent. Thus, these people argue that inflation should be allowed to rise as the corresponding rise in output shall compensate people enough and enable them to counter inflation. But they seem to have forgotten that the people at the bottom of the economic pyramid i.e. those below poverty line and those just above it shall hardly experience any rise in their incomes and inflation would lead to further worsening of living standards for them. Thus, inflation no doubt is a serious problem to the economy which has to be dealt with effectively. But equally true is the fact that the current inflation is not one which can be decreased overnight. Only proper medium & long term measures can help bring this figure down. Until then, patience is required from the people to maintain political and social stability in the economy without which, this problem can never be dealt with. Chillibreeze's disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect the views of Chillibreeze as a company. Chillibreeze has a strict anti-plagiarism policy. Please contact us to report any copyright issues related to this article.
>> Read more articles written by Chillibreeze writers:1. Articles related to Content and Outsourcing
|
Premium Services
Products Must Reads...
Upgrade Your Writing |
Copyright 2004 - 2011 Chillibreeze Solutions Pvt. Ltd. |
