India's headline annual rate of inflation, based on the monthly Wholesale Price Index (WPI), rose to 9.44 per cent for June 2011 as compared to 9.06 per cent for the previous month and 10.25 per cent in the corresponding month of last year. Provisional data released by the government showed that India's food inflation rate had risen to 8.31 per cent for the week ended July 2, 2011 from 7.61 per cent for the previous week. The inflation rate for fuel and power, however, eased further to 11.89 per cent from the previous week's level of 12.67 per cent. In the past one year RBI has enforced eleven successive rate hikes on the banks with the outlook that an increase in the bank’s lending rate would entail a tight grip on the flow of money and this would cause the inflation to come under control. Inflation has been above the eight per cent mark since January 2010, much above the government's comfort zone of around five per cent. However a cursory glance at recent trends in the major segments: consumer goods, energy and fuel which have a direct impact on inflation reveal a different picture.
The increase in price have mainly been supply constrained (cost push) whereas the countermeasures taken by RBI has been to control the demand (demand pull). The twin factors of cost push and demand pull have caused soaring inflation, but the government with the aid of RBI has focused only on the demand side by monetary policy. The supply side also needs to be focused upon. The tight monetary measure introduced by the RBI can at best only be able to, in the short run, curtail demand for consumer goods and energy and curtail the supply side. This measure will discourage investments and worsen the supply-demand gap in the long run. On the front of essential commodities such as food, the current monetary measure would have a negative impact because the increased food prices would eat into the family’s savings and investments, further the families cannot postpone their purchasing decisions on essential commodities owing to inflation. Hence it is a given that in the long run, inflation would resurface with a vengeance and tackling this source of inflation would be a challenge.
An exceptional rise in the middle class having a higher disposable income has added to the woes of inflation currently plaguing the country as this event in the economic history of the country has its own impact on inflation. Further the government policies and schemes such as the sixth pay commission, loan waivers to farmers have increased the amount of money in the hands of the consumer. This increase in disposable income which has percolated across the social fabric of the nation has resulted in a substantial increase in the consumption pattern for food and consumer goods. India needs to have a comprehensive plan for controlling inflation in the long run and this is possible if we can create adequate supply in all sectors. Economics teaches us that economies are at their most efficient when they grow at their production possibility frontier, which is a function of the basic resources - manpower, capital, and infrastructure - available in the economy. As economies expand at their natural pace, it accumulates these resources, and a positive virtuous spiral of growth is generated. However, when the economy experience a sudden growth spurt, wherein the trend rate of growth is suddenly lifted up, the available resources often get depleted quickly and its growth may fail to keep pace with the needs of economic expansion. The economy is said to be ‘over heating’. This is the situation that India is presently in.
Supply side problem leads to spiraling food prices. This is largely because of faulty policies in the regulation of the prices of food grains, an increasing dependence on the food corporation of India for storage of primary food grains ( In July 2011, the Allahabad high court has issued a notice to FCI and the state government asking for an explanation of food grain rotting in the open in the state) , the appalling connectivity and transportation conditions between villages and consumer areas, and the lack of modern specialized warehouses for storing perishable commodities such as vegetables and fruits . The development of infrastructure to curtail these misgivings needs huge investments and an open environment of competition. The government could open this sector to private firms as it would foster better management and would avoid the government from getting a tarnished image as regards to important issues such as rotting food grains (Our honorable minister Mr.Sharad Pawar & FCI are an epitome of burden to the government exchequer by the way they handled the food grain crisis in 2008 which was estimated to have caused the government an estimated loss of 10 lakh tones of food grains).
Its also a well known fact that although 50 to 70% of the population is employed in the agricultural sector, this sector is contributing the lowest the Indian GDP. This trend is a cause of concern as we as a nation have not been able to leverage the benefits of liberalization in this sector as compared to that accrued to the industries and services. The government has to educate the farmers on the modern practices in arable land. Till date the agricultural industry output has been fluctuating based on seasonal rainfall patterns in the country. For a country which is having an 8 to 9% economic growth per year, India must try to remove the barriers of supply constraints posed by agriculture (based on seasonal rains).
Secondly, we don’t have a structured monetary framework. The RBI’s prime focus is on exchange rate monitoring and control, and it is not held accountable for price stability. Adding to the woes is the fact that, the monetary policy transmission is weak. Various capital controls and regulatory prohibitions have prevented the bond market, the currency market and the banking system from properly passing through policy changes. The result is that, when the RBI changes short-term interest rates, this has a limited impact upon the economy. Even if interest rates were raised today, a substantial impact on inflation would take time to shape up .
In addition to the above, it is the need of the hour that we engage in proper supervision of the energy usage patterns to curtail price inflation on fuel. We should encourage the development and use of hybrid vehicles and fuel cells that can also operate on batteries. TATA and Mahindra have already started development procedures of vehicles which will have a reduced dependence on fuel as a prime mover for transportation. We still lag behind developed countries in the innovation and development of energy saving apparatus. The above is just an example of implementation of energy saving activity undertaken in one sector. The same has to be implemented across all sectors (Horizontally deployed). Such an activity will not only bring down energy cost will also create new job opportunities in the country.
In a nutshell, aggregate demand is on the up and the supply infrastructure and other basic resources are not keeping pace with the requirements, and hence inflationary pressures are inevitable. To tackle the situation, it is imperative that the government focuses on creating adequate supply in all sectors and controls demand through effective monetary policy. This is feasible if there is adequate political will.
As said in the macro economics class we need to view economics not in isolation but in combination with the political dynamics of the country. What India currently needs is an increased political will and focus on improving the supply side, if we have to manage the problem of inflation and this can only happen if the government invests the time and energy to chart out a long term strategy for sustained growth for which the political fraternity has to look beyond the current short term gains envisaged through vote bank politics.
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