Inflation - Flatened

7/31/2019 Inflation - Flatened

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INFLATION FLATENED

What is Inflation?

The simple definition of Inflation is Chasing of too few Goods by too much Mon-

ey. That is, there is a mismatch between circulation of Money (demand) andavailability of Goods (supply). When the increase in money circulation ismatched by increase in goods availability, the inflation subsides. It is obviousthat in a growing economy, always money has to be spent first (by wayof capital, wages, consumables, etc.) to produce additional goods and hence in-flation has to be there at any point of time. But to what level and how long is abit complex phenomenon( but not anything great that you need to be an econo-mist to understand it). However, inflation beyond certain level, if leftunchecked, will result in speculation and spiraling of prices.

In a normal state of an economy (abnormal state being after big wars, after longdrought / flood, after major investments in long gestation projects, etc), theinflation has a self regulating mechanism. If a particular commodity is inshort supply, its price will increase in Short Term and automatically its produc-tion will increase, as more people will come farward to produce that particu-lar commodity. Also there could be possibly some reduction in demand as welldepending upon whether it is an essential commodity or not. This is called PriceElasticity. This is simple economic principle.

How it is measured?

In India it is reassured in terms of rate of increase in Wholesale Price Index (WPI)and it is released every week. It has the following three main components withtheir weightages given in brackets:

1. Manufactured Products (63.75%)

2. Primary Articles (22.02%)

3. Fuel, Power, Light & Lubricants (14.23%)

These three are made up of a host of related goods with individual weightagesassigned to each item, depending upon their importance in economy and itsshare in GDP.

The WPI as on March 22 08 was 224.8 as against 210.11 on the same day lastyear, which works out to 6.997% (~ 7%) increase. We call this increase as Infla-tion on Point to Point basis.

Causes for long duration inflation?

As explained above, Inflation beyond normal level will correct itself over a periodof time in normal course. But the time period depends upon various factors likewhether the inflation is due to

1) Short supply in only few goods (or )many goods.


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2) Price increase in certain goods which have immediate cascading effect(like Electricity,

Transport Fuel, etc) (or) in other goods.

3) Excess money supply is sudden (or) gradual

4) Sudden increase in money supply by way of increased salary for orga-nized sector (like payment of DA / Pay Commission arrears, etc.) (or) byway of Govt. spending on direct productive investments.

5) Implementation of major infrastructure projects which have long gesta-tion periods (Large

Dams, Power Projects, etc) (or) short gestation Periods.

6) Implementation of major supporting infrastructure Projects which direct-ly do not produce

any goods by themselves (like Roads, Airports, Railway Lines, etc.)(or) Projects which

contribute for direct production (like Dams, Canals, Mining, etc.)

7) Major investments in Industries which have operated at low capaci-ties (like all PSUs

which were operating at very low capacities till about 10 yearsback).

8) Short supply of imported goods over a long period (or) for a short peri-

od.9) Short supply of Food items due to draught continuously for few years

(or) one year only.

10) Short supply of agricultural raw materials(Cotton, Sugarcane, Jute, etc)(or) other raw

materials.

11) Overall economic growth is by way of one or two segments of econo-my (or) it is due to

equal growth by all segments.12) Economy has abruptly accelerated / decelerated in a year (or) there

was smoothtransition.

13) Continued spending on Non-plan expenditures which do not contributeto any

commodity production like Defence, Service Sectors, FoodSubsidy(not all subsidies), etc.

The above are a few factors responsible for inflation. In the above examples, thecauses first cited will generally have longer inflation duration and the secondones will have shorter duration.

Why the Governments are so sensitive?


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In developing Countries like India, people are supposed to be spending sub-stantial part of their income for food. Whether this is true today in India is a de-batable point. For any reasons, like Draught, Flood, Pest, etc (or) excessive ex-port of food items, (or) due to hoarding of food items, if there is shortage of fooditems, the prices of food items will instantly soar, since food has to be bought atany cost. This will hurt the poor most lot in the society. Hence, any Govern-ment has to be sensitive to this issue.

To this extent, the response of the Governments to inflation is understandableand justified whenever there are Food price increases. But in most of the occa-sions, the inflation is driven by factors other than the food products price in-crease. In fact, the weightage of primary articles (comprising mainly Food prod-ucts) in WPI is hardly 22%, and hence unless there is substantial increase in theirprices, the WPI will not increase. Hence, it is obvious that inflation is drivenmainly by Manufactured Products and Fuel, Power, Light & Lubricants group.

Given this reality, the knee jerk reactions of our Governments (and of course, theOpposition Parties) to inflation is only counterproductive. In fact, it is yet anotherfraud on Agriculture. This aspect is discussed later in this Article.

What are corrective measures for Inflation?

There are a few standard Text Book measures being followed for reducing Moneysupply and increasing goods availability. Those are listed below:

A. Reducing Money Supply:

1. Increase the Bank Deposit interest rates and encourage people to savemore money.

2. Increase the Bank Loan interest rates and discourage industries/ peo-ple from borrowing more loans.

3. Increase the statutory Cash Reserve Ratio (CRR) of Banks. A part of theDeposits of all Banks shall be kept in RBI at a nominal interest rate toensure liquidity and this is called CRR. An increase of 0.5 % ( they callit as 50 basis points - for whatever reason) in CRR today, reduces thelending amount of Banks by about Rs. 18,000 Crores.

B. Increasing Goods Availability:

1. Reduce exports by introducing Quantity restrictions, Quality restric-tions, Increasing Minimum Export Price, withdrawing export benefitslike ; DEPB, etc.

2. Increase imports by measures like, reducing Customs Duty, relaxingquality norms, etc.

3. Take measures to minimize hoardings by increasing interest ratesfor stockists on selective basis.

4. For Food articles, increase the supply from Buffer stocks through Pub-lic Distribution System.


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Apart from the above standard methods there are a few other unorthodoxmethods also. They include changes in RBI interest rates to Banks / Govern-ments, Budgetary changes for Plan and Non-plan expenditures, direct advice /direction by Governments to various Manufacturing Organisations to controlprices, Minimum Support Price changes, etc.

It is really a mystery that no one ever talks about ways and means of increasingthe supply of commodities by increasing the productivity or reducing consump-tion by increasing Recycling / Efficiency of utilization / use of alternate commodi-ties, etc.

For example, when the Crude price has increased from USD 40 to USD 115 in thepast three years, why we did not increase the Public Transport System in a bigway and reduce the overall fuel consumption ? Why we did not increase theEthanol production by increasing the Ethanol Purchase price in tandem withCrude price ? After all, we all know that, we are paying through our nose for theimport of Crude Oil.

When Rice / Wheat production is almost stagnant in the past 10 years, why wedid not increase their Minimum Support Price (MSP) substantially to boost uptheir production. The rhetoric of India having achieved self sufficiency in Food isa myth. Today, India has the highest malnourished children in the world ! If theprice of Rice / Wheat is very critical, why we are spending just 0.1 % of our GDPon Agricultural Research ? Instead of asking the Rice / Wheat to be sold at acheaper price, all the Employees of Fertilizer companies can be asked to increasethe productivity of Fertilizer Plants, which are running at abysmally low capaci-

ties.

When Vegetable prices rise, we react so instantly. But when the tomato is thrownon the roads and Onion is left in the field itself for want of Buyers, we turn blindeye to them ! When there is shortage, we have to adjust only. Cant we reducecooking oil consumption for a while? Why we should insist on import of Palm Oilat any cost, thereby killing the drive for increasing the domestic production ?

Also, no one is bothered to question the rationale behind a huge spread of 4 to 5%( difference between the average interest rates paid to deposits and the aver-age interest rates for loans ) enjoyed by the Banks. Actually, this is one of thereasons for higher interest rates prevailing in India, apart from causing base lineinflation level.

Essential Commodities price - does it really affect the so called Com-mon man ?

It is a myth that the inflation affects the common man ! When the inflation is 3% or 8 %, neither the Cinema Theatre collection nor the crowd in the Jewelryshop reduces ! When we are ready to pay for Diesel / Petrol, even if it is raisedby 50 % in a year, why make so much fuss when Milk price is raised by 10 % af -ter 3 years ?

For the top 50 % of our population, the fraction of their income spent on essen-tial commodities is hardly 30 % ! Even for the bottom 30% population, with the


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establishment of a strong PDS network, the fraction of their income spent on es-sential commodities is not more than 50%.

But nevertheless, in recent years, the income disparity is increasing at an alarm-ing rate and the bottom 30 % of the people are being pushed to the wall, espe-

cially the rural poor. For that, keeping the food prices alone cheap is not the so-lution. It will only reduce the food production and further push up the prices.

Take the money from the pockets of the top 10 % and put it in the bottom 30%peoples pockets by increasing Income tax / Wealth Tax or increasing ExciseDuty / Sales Tax.

We can not expect only the farm products to be kept at low prices all the time tohelp the bottom 30% people, especially when 70% of the bottom 30% populationare farmers themselves !

What is tolerable level of Inflation?

As explained earlier, Inflation is self regulatory, in normal course. The move-ment of WPI will primarily depend upon the growth rate of economy, with certainlead time, say 6 months to 1 year. Hence, the best the Government can do iskeep off and watch until it is double of the growth rate %.

If the price of a particular commodity rises, it is obvious that it is in short supply.Automatically more people will get into its manufacture and price will fall. Forexample when vegetable prices rise, what Government should do ? (or can do?).If they ask the Banks to increase the interest rates, will the price of vegetablesfall? Or if the MPs march to the Parliament, will the production of Crude Oil in In-dia will increase ? If they talk to the ONGC Employees to produce more, there ismeaning in it.

Only in case of mass production items, where there are only few manufacturers,and there is scope for cartelization (like Steel, Cement, Chemicals, etc.), the Gov-ernment shall have a close watch and interfere. In all other cases, includingFoods Products, the Government shall not interfere in the inflation, whatevermay be the level. On the contrary, the Government shall always ensure that theprices of essential commodities do not fall below certain level by suitable marketinterventions.

If a particular essential commodity price falls below remunerative price, in thenext season many will opt out of its production, which will automatically causeinflation next year.

Inflation Control / Remedial steps, are they justified?

Whenever a particular commodity is in short supply we respond with a knee jerkreaction. Either we import or restrict exports of that commodity. When we im-port, we kill the driving force for increasing the production of that commodity.When we curtail the exports, we kill the opportunity for further growth. In a par-

ticular year if we stop exports, in the next year, the customer will not enter intocontract with you since you are not reliable. Also, it becomes next to impossiblefor any Indian companies to enter into Long Term International Contracts, giventhis kind of Government interventions.


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Another response to inflation is giving Dearness Allowance. This is totally aridiculous step. The inflation is there because already there is excess money inthe hands of consumers, and that too in the hands of top 70% of the population.Now, by increasing the DA, Government is placing more money in the hands of organized sector employees, who fall in the top 20% of this top 70%! Firstly,when inflation is common to all, how only one section of the society can be sup-ported? Secondly, by putting more money in the hands of affluent society only,we are making the vulnerable poor section of the society more vulnerable. Thevery purpose of our intervention is lost.

The third step is increasing the subsidized Food Products supply through PDS. This will automatically bring down the food products price. No doubt. But, then if food products price alone is brought down or artificially kept low (which has beenthe policy of Indian Governments all these years), saying that it falls under theessential commodities and all other prices are allowed to rise as per market

forces, we are directly robbing the farming community to feed the non-farmingcommunity. We are transferring the hard earned wealth of the farming commu-nity to the hands of the non-farming community. When we say farming commu-nity, it includes the unorganized poor people living in rural areas, who constitute70% of the bottom 30% of Indian population.

We are indirectly saying that, as a policy, we do not want the production of es-sential commodities to increase !

OK. All said and done, essential communities are essential for the livelihood.How can we afford to leave the poor people to fend for themselves?

The solution is simple. You put more money in the hands of poor people by in-creasing the salary under the Minimum Employment Guarantee Programme orby any other means based on inflation. If you want to directly give food prod-ucts, you increase their wages and give part of their wages as food products atMARKET PRICE, so that market dynamics is not disturbed.

This is simple common sense. We need not read DAS KAPITAL or we all neednot be Manmohan Singh to understand Inflation !

K.Periasamy, Chennai -96

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Inflation - Flatened