Why inflation is refusing to come down

Even if one were to assume vegetable prices would self-adjust, owing to 'seasonal' factors, one still needs to pay careful attention to other commodities like cereals and milk.

 |  4-minute read |   19-01-2020
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The inflation code, decoded

The Consumer Price Index (CPI) inflation measuring the average rise in prices for basket of goods most frequently consumed by households in India, peaked to 7.35 per cent in December 2019 from 5.54 per cent in November. This was well above the market expectations of around 6.2 per cent.

Expensive tuber

This effect, sourced from galloping food inflation, can largely be explained by a consistent push seen by the rise in cost of food and beverages (12.16 per cent), within which vegetables (60.5 per cent) and pulses (15.44 per cent) saw the highest jump. Cereals (4.36 per cent) and Milk (4.22 per cent) too witnessed a sustained increase among other components. The rise in cost of vegetables (i.e. over 60 per cent) can largely be explained by the price-behaviour of onions, which is surging to almost Rs 200 per kg in cities. Higher onion prices could have been perceived with more optimism had they led to an increase in farmers' incomes. Onion prices have seasonally witnessed a greater degree of volatility due to supply-side factors and role of certain policy measures (like MSP ratesetting).

A high CPI inflation rate is bad news and, at this stage, it is even more puzzling. Components of CPI inflation are peaking at a time when average demand has been dismally low, real wages are falling, unemployment growing, further aiding a fall in average consumption and production levels for both, consumer and capital goods. With the mandate to keep CPI inflation low, a higher inflation rate also restricts the RBI's mandate to remain more 'flexible' with its monetary policy going forward. Even if one were to assume that vegetable prices were somehow going to self-adjust over time, owing to 'seasonal' factors, one still needs to pay careful attention to other weighted (essential) commodities like cereals, milk and pulses, which occupy a higher 'weight' (in terms of importance) than vegetables in the CPI measurement and have been seeing a higher price rise for months now.

So, what explains this?

And how are prices of these components (food inflation) rising when their average production has been low? The answer to this lies in understanding the role of recent government policy in being responsible for the current trends in food inflation, and its subsequent effect on CPI. Take the case of pulses, where a higher import from other countries (with 50 per cent imports coming from Myanmar and Canada) in 2019 allowed for a higher supply of pulses in the market then, but at a lower price realisation, which ultimately reduced its domestic production this year (as farmers saw less price-driven incentive to grow more pulses). Further, wheat prices have risen at somewhere around 8 per cent this year, despite low average wheat production, which is almost bizarre.

Granular factors

This is due to a poorly managed and administered public distribution system, where the government procured more than 34 million tonnes of wheat in 2019 (on top of 36 million tonnes in 2018) but couldn't distribute this properly. A lack of effective distribution means a more than necessary buffer stock with the Food Corporation of India, thus creating an artificial scarcity and causing the price of wheat to rise. This policy does more harm than good to both farmers and consumers. Farmers at source, even if wheat prices rise at retail level, get a very low share in any price-accrued benefits due to the presence of intermediaries in the supply chain. And consumers, particularly those belonging to low income (and poor) groups will take the burden of high price on their own pockets.

For worse, this muddled economic intervention can keep the CPI inflation level high for months to come, making the RBI even more cautionary in its monetary policy stance by holding off any potential rate cuts at a time when the government and the RBI must actually be coordinating to facilitate a series of quantitative easing measures, to boost spending for a higher aggregate demand A self-goal Amid all this, and contrary to the CPI inflation trends, Wholesale Price Index inflation grew at a low rate of 2.59 per cent in December 2019.

The Producer Prices Change - measuring the average change in prices of goods and services sold by manufacturers and producers in the wholesale market in India over a period of time - was around 6.9 per cent between 1969 and 2019. Lower producer prices, seen in current context, not only signal a more negative, chronic industrial sentiment but also indicates a lower ability for industrial wages (as cost or price of labour) to go up over time. In a developing economy, with a large labour force such as India, one does want the market price for labour to go up at a sustained level - marked by a higher producer price change, for better wage growth. This will only happen if the corporate sector intends to invest more in building new capacities. However, from the current wholesale (producer) price level numbers read in alignment to the net fixed asset growth level (seen at a meagre 5.3 per cent), the corporate (and industrial) sector seems to have almost stopped investing in building new capacities. And this is extremely worrying.

(Courtesy of Mail Today)

Also read: 2020: A Do-or Die Budget for the Indian government

Writer

Deepanshu Mohan Deepanshu Mohan @prats1810

Assistant Professor of Economics, OP Jindal University; Director, Centre for New Economics Studies; Visiting Professor, Department of Economics, Carleton University

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