How To Slay The Inflation Monster

As price rise continues unabated despite assurances from the government, five
experts assess the hard facts, and chalk out pragmatic strategies to check inflation.
TEXT SIZE : A | A | A
TOOLS
• e-mail this story
• print view
• view only pictures
• story in single page
• share

(Clockwise from top left) Bimal Jalan, T.C.A Anant, N.K. Singh, Saumitra Chaudhuri
and Abheek Barua (Photographs: Sanjay Sakaria, Bivash Banerjee, Tribhuwan Sharma,
Dileep Prakash)
RELATED STORIES
• Bottlenecks To Prolong Inflation
• Politicians’ Fictions
• The Spoils Of Games
• Reading The Signals
Inflation has no easy answers. the sheer volume and time spent by finance minister
Pranab Mukherjee trying to mollify Opposition members in Parliament last week on the
issue was evidence of that. As Parliament came to a standstill over the issue, the finance
minister spent most of his time answering what the government could do and has done to
contain this demon. The Opposition was vehement that the Centre needs to take stronger
actions to contain price rise. That there were no straight solutions to this complex
problem was evident in the finance minister’s painfully detailed answers to queries raised
by members of Parliament.

Making matters worse is the fact that what started out as a rise in food prices has spread
quite rapidly to non-food commodities. Prices of non-food articles have gone up by more
than 21 per cent (24 July 2010) over the same period last year, while the rise in food
articles has moderated to below 10 per cent. Voices predicting what may happen by the
end of the year are also getting weaker. Economists and bureaucrats are now wary of
predicting what may happen since past forecasts appear to have been hasty and, in many
cases, proved wrong.

But what happened between September 2009, when inflation was 0.5 per cent, to March
2010 when inflation peaked at 11 per cent? Could the Centre have tackled it differently?
Could the Reserve Bank of India (RBI) have stepped in earlier to tighten liquidity?
Should oil prices have been raised at a time when such a step could worsen matters? Did
the Centre release buffer stocks as early as required?

Businessworld spoke to a set of economists and one Rajya Sabha member to see what
they think could, or could not, have been done. Second guessing is a mug’s game and, in
hindsight, it is always easy to say what ought, or not, to have been done. Yet, it needs to
be done to avoid mistakes in future. One view that emerged is that rather than dedicating
all its time trying to tame the dragon, the Centre’s time may be better spent in mitigating
the impact on the poorest sections. Others felt open market operations could be used
more effectively by the government, while a few said the RBI could have stepped in a
wee-bit earlier to tighten liquidity. But there are no magic wand solutions to this
problem, something this and subsequent governments have to learn to live with in the
short- and medium-term. Read on.
 Who is responsible and who is not is not the primary issue. The
issue is how to do what needs to be done. BIMAL JALAN
(Bloomberg)
‘We Have To Change Expectations’
Bimal Jalan, former governor, RBI

What steps need to be taken to contain the soaring inflation?

There is a standard package. On the demand side, there is the need to control the total
effective demand in terms of fiscal deficit or in terms of total credit flow. On the supply
side, there is the need to increase the supply of goods. The point is that the imbalance
(between supply and demand) has gone on for too long. And why it has been continuing
so long is the real issue. Inflation was expected to come down in March-April 2010. And
then in June. A positive is that the monsoon has been good. If that doesn’t happen, do we
have a plan?

From the supply side, is reducing food stocks an option?

Of course, anything that needs to be done should be done. Especially if the country aims
at 5 per cent inflation, but it remains at 10 per cent.

Are there any short-term solutions to tackle food inflation?

We have to change expectations. On the food front, supply is, to a large extent, subject to
government control. So far as the demand side is concerned, that is open. We need to do
whatever needs to be done to change inflationary expectations.

Is the ban on forward trading an option to contain food inflation?

In a situation where future prices do not result in increase in market supplies, then you
have to consider it.

How important is the interest rate instrument in checking inflation?

It is essential to change inflationary expectations. But it is an established view that
interest rates have transmission lags.

How do you think the agriculture ministry has handled the situation? Has it done
enough?
I don’t want to comment on a specific ministry’s role. But it is a fact that prices of food
are high when foreign exchange is not a problem, when monsoon is good, and when food
supplies are available. Who is responsible and who is not is not the primary issue. The
issue just now is how to do what needs to be done — and to do it fast.

Was decontrolling petrol prices a good move at this stage?

With subsidies and fiscal deficit being high, something had to be done. The timing, one
can say, could have been different. Probably, that was right; it hasn’t had too much of an
impact so far. This is not the time to do anything that can impact prices. But if fiscal
deficit has got out of hand, then there is always a trade-off in economic policy.

Have we seen the worst or is the worst still to come?

I don’t know. Since monsoon has been good, the probability is that inflation should go
down. But we cannot be sure, and we must take action to ensure that inflation falls
sharply in the next two-three months.

We need to improve our food intelligence. We must know

behavioural trends. N.K. Singh (BW pic by Tribhuwan
Sharma)
‘The Right Approach Was To Release Stocks’
N.K. Singh, member, Rajya Sabha

Has inflation been mismanaged by the Congress governments?

I do not want to draw political conclusions. But when Congress has been in power,
inflation has been high, and the inflation on the industrial workers index was low when
non-Congress governments were in power. But if an ancillary point is made about growth
versus inflation, it is intellectually and methodologically flawed. Economic strategy must
reflect high yield, high growth with modest inflation and high employment.

So, what should be done to contain inflation?

When prices were falling globally, the government adopted an aggressive food
procurement programme. When there were enough food stocks, the right approach should
have been to release that and allow market forces to act. That would have allowed
demand and supply to function, and the prices would have been in sync with global
prices.

The government also did not undertake any significant open market operations. The fact
that too many entities were dealing with the food issue — such as cabinet committee on
prices, finance minister, PDS — was not good. There is need for one empowered entity.
We need to improve food intelligence. There is an urgent need to know behavioural
trends. To know what crop is being sown in other countries, what are the likely trends in
growth of those crops, the weather trends, etc.

Was dismantling administered price regime (APM) appropriate?

I am in favour of it. There is an economic logic in doing so. You cannot have both — a
skewed central policy and APM. If APM is dismantled, all the under-recovery (by PSU
oil companies) issues will be gone.

Will introducing the goods and services tax (GST) change this imbalance?
Sadly, uncertainty will continue even in the post-GST era. The government is also not
doing anything to restructure the PDS, despite recommendations from the N.C. Saxena-
and- Justice D.P. Wadhwa committee. The RBI too concluded inflation might have been
due to supply side responses, but later said it was due to demand issues. But the action to
manage this was delayed a bit. Further, not much has been done to manage the supply-
side elasticity. The cultivation area has also shrunk and productivity has plateaued. The
special agriculture plan has not been carried out properly. The government also does not
have a crash programme to reduce wastage.
What should be done at this juncture?
We should have conditional cash transfers to BPL families, while the PDS should be
restructured. We have to try new models, without getting stuck on PDS, which has not
performed for the past 60 years.

So, is the problem on the demand side?

In a general equilibrium model, you need to operate in both. Demand side is a larger
issue, whereas spillover of food inflation into a more generalised inflation is a core issue.
If you have a strategy that is led by consumption instead of investment, then demand-side
management is an issue. On the supply side, we need to take care of wastage. More than
45 per cent of the food and vegetables are wasted.

Opposition parties have sought to ban forward trading. Is it justified?

I am not sure about that as a panacea. Forward trading gives an indication of likely trends
in behavioural pattern. Why should the government shut that? This is the Left parties’
biggest point.

Could the RBI have intervened earlier?

The RBI has been following an accommodative monetary policy for far too long. It has
done an incredible job, and is trying to balance: not killing the investment and not killing
the long-term beneficial impact of stimulus package and growth. Now, they are trying to
manage the inflationary expectations. They should have acted a little earlier.

‘Boost Farm Productivity. Modernise Distribution’

Saumitra Chaudhuri, member, Planning Commission

Do you think that the worst is over as far as inflation goes?

For food price inflation, the worst was over during January-March 2010. Food prices
reached a peak around end of December 2009 and slowly started falling.

"Hoarding is not the cause of inflation. We need to use our stocks

in a manner that the market is well supplied. SAUMITRA CHAUDHURI" (Pic by Sanjay
Sakaria)
Prices rise in difficult situations, but they don’t come off easily either. In commodities
such as rice and wheat, prices have stabilised. Pulses have come down from 40 per cent
to 20 per cent, but are still high. In fruits and vegetables, the supply has been strong.

In milk, the inflation is still around 20 per cent. This is caused by higher demand. Milk
responds slowly to meet the increase in demand. It takes three years to increase the
productive stock. But the key is to keep grain prices stable. That is where the government
can do something. It has official stocks. What can it do with milk? It has no stocks.

When there is pressure on the demand of wheat and rice, you need to increase supply.
You have to release stocks either through open-market sales or through the PDS. Open
market sales play an important role here.

But stocks have partly been destroyed due to poor storage conditions...
It is very regrettable and should certainly be avoided. But we have 50 billion tonnes of
wheat and rice in stock; so the amount lost is not that large. But even 100 tonnes of wheat
getting spoilt is terrible.

On the monetary side, some experts say the RBI should have stepped in earlier?
Too many people make their profession by double-guessing. In September 2009, inflation
was at 0.5 per cent. Only in food prices was there was any sign of inflation. Global prices
were moving and the domestic economy was growing stronger. Adjustments have to be
sharp and rapid. Rapid adjustments are always uncomfortable, and monetary policy
changes have a lagged effect. After all, we moved from a crisis situation to an
inflationary situation in six months.
Do you think there was a need to hike prices of petroleum products?
Yes. If this had been done in December 2009, the year-on-year inflation rate for
petroleum products would have been lower. We did not do this last year partly because
we had a drought and there were doubts whether we were coming out of the financial
crisis.

The opposition says forward trading of many commodities should stop.

That is not the way to fight inflation. Forward trading is like any other trading activity.
There can be misuse. What’s needed is better regulation.

What about de-hoarding? Will this help in reining inflation?

I don’t think hoarding is a cause for inflation. To be honest, who has the largest stocks in
the country? (The government.) The word hoarding has a pejorative content. The
government may be “hoarding” stocks for a good purpose and somebody else may be
doing it for a bad purpose. But that is in the eyes of the beholder. We need to use our
stocks in a manner that the market is well supplied.

What steps can the government take to ensure inflation is contained?

The government is going to be a large player in the food grain market. It needs to ensure
good management of food stock and it has to leverage this position to curb inflationary
expectations at an early stage.

Should the government have stepped in earlier?

What we need to say is that going forward, what do we need to do? The standards of food
management have to be much higher. We are now a bigger economy, people have more
money, demands are larger, and quantities involved are larger. What worked 15 years ago
won’t work well now. But all these — open market sales, etc. — are only short-term
measures. If we want to solve the problem of food inflation in the long term, there are
only two solutions: increase farm productivity and modernise distribution.

‘Managing Deficits Better Will Help Check Inflation’

T.C.A. Anant, chief statistician of India

To what extent can interest rate adjustments help inflation?

One contains demand through managing liquidity. If demand is low, prices will be in
check. But we must keep in mind that interest rate policies are only moderately
successful in containing inflation. In the 1970s, when inflation was very high, interest
rates had gone up higher than they are now (15-16 per cent). But prices were still high.

The poor should get some certainty on basic necessities. We

should have an effective food security system. T.C.A. Anant (BW
pic by Bivash Banerjee)
Last year, the government took a series of steps to mitigate the
impact of the recession. Some of those steps, combined with a
shortage of food arising due to the failure of rains, created a perception that prices would
rise.

Inflation is largely an expectational phenomenon. Monetary policy is effective in

managing inflation in two ways: through short- and medium-term liquidity management,
and in the signal that it gives to the expectational process. As of now, we don’t have a
major expectational problem for inflation. There may be some short- or medium-term
liquidity issues, and those are being managed through a variety of steps. They can
certainly be better managed if the government controls its deficit.

Will a ban on forward trading of certain commodities help?

The link between inflation and forward trading has not been well brought out. Better
information can, sometimes, lead to tightening inflationary expectations. So, I am not so
sure if the absence of forward trading will make such a difference. We tend to be wary of
things which are new, and often look for manipulators where they may not exist.

Hoarding is another issue that many say is causing the problem.

I am not saying hoarding does not occur. There may even be a case for stronger policy
action. But it is not a primary reason behind inflation.

Is the worst over for the year? Is inflation here to stay?

We are not likely to see inflation grow worse. It will come down, but I will not say that it
will happen this month or next month. By the end of the year, prices will come down.
Once it dips below 8 per cent, the general pressure will be off. Shortages may remain or
come up in some commodities, but the overall picture will ease. I also don’t think prices
have gone up alarmingly. We have seen higher rates. But inflation will not go away. As
more items become tradable, our prices will come closer to global levels. One of the
reasons why prices will not go up further is because the global picture in prices at present
is good.

Also, some of the non-food prices inflation is cost-push. Food prices feed into the cost of
every item produced. Inflation is part and parcel of being in a market economy. Some
amount of inflation is also good because for every producer a modest price rise insures
him against losses.

Also, prices signal to producers that the demand pattern has changed and that the
production pattern must change in response to this. If you created an economy in which
you artificially froze prices, you would end up in disaster. You would be producing the
wrong sorts of goods. Take the example of the Soviet Union in the 1950s and 1960s.
Huge amounts of some goods were being produced and there were huge shortages of
others. The inflation never showed up because prices were artificially controlled.

What can we do to prevent the kind of price rise we have seen recurring?
You can’t. Market economies come with a cost. The question therefore is if there are
things we can do to mitigate the impact of inflation on the poorest sections. I am not sure
of what can be done to control prices. But we can take it from the other end and reduce
the negative impact of rising prices on the poorest sections. We need to ensure that these
sections get some certainty on employment and basic necessities such as food. We should
have an effective food security system.

‘There Has Been A Failure On The Supply Side’

Abheek Barua, chief economist, HDFC Bank
Could the inflation have been managed better?
There has been a considerable failure on the supply side, especially last year, following
the rise in food prices. The problem of inflation was primarily related to food and
agriculture prices for quiet a while. From January (2010) onwards, it started turning into a
more generalised problem. It certainly could have been handled much better, using the
PDS, or imports.

Any specific measures that should have been taken?

Inflation is coming under control. There are two phases in this episode. The first was the
huge failure on the supply side, following the hike in agriculture prices. It started with
pulses and then flowed into vegetables, fruits, milk and other categories. This is slowly
coming under control.

There were two phases — the first was a huge supply side failure
and the other, generalisation of inflation. ABHEEK BARUA (BW
pic by Tribhuwan Sharma)
The other phase, which we saw after January, was that of
generalisation of inflation. That is the corollary of growth. That
has started picking up, and is reflected in the traction of non-food articles such as
chemicals, textiles and automobiles and an entire bunch of categories. We see the
reflection in the consumer price index. This is linked to the pick up in growth, and that
needs more monetary measures to control it.

Going forward, what we are looking at is a considerable moderation in food prices; base
effect is also favourable. So, by end of this calendar year, we should look at inflation of
6-7 per cent, and by end of the fiscal, perhaps, further lower.

So, in between, there are certain structural policy measures that has added to certain
inflationary pressures — like the oil price revision. Some of it was necessary as it comes
as part of the fiscal correction package and it would have inflationary consequences.
However, the RBI is stepping in to check some of the second round impact of inflation.
Hence, I would not be worried about the inflation now, as I would have done 3-4 months
ago. But six months ago, some measures could have been taken aggressively to counter
the price pressure.

Do demand side controls need immediate priority or supply side?

It is an old debate. Supply side was important. But this was an issue between July 2009
and February 2010. There was a failure on the supply side, given the massive failure in
supply management. But it is getting sorted. We are seeing fairly strong measures.

I don’t deny that there is a massive problem of food prices. But that has been done and
dusted. Failure of the government has been recognised, and it is time to move on. I would
put that on the back burner. But today the problem is of general inflation.

How much should we blame it on the fact that the base of our indices hasn’t been
revised (the WPI base year is 1993-94)?
Yes, we could reduce the impact of base. If you bring down the impact on agriculture and
food categories such as sugar that spike up sharply, you would see some help at the
margin. But it will not relieve the pattern of inflation significantly. There are other
problems, not just the base year. The collection agencies have been known to be
inefficient. The CPI basket is dated, and the entire collection mechanism was put in place
a decade back. There were complaints on the base, and the data they pick up are
misleading.

So, there are bigger issues. The base change and basket change, which has not changed
for a long time, will help. I do not think it will alter the pattern of inflation. Because the
hike in the food prices, in certain categories in general, is significant. Any index, however
different the base year is, will pick up very sharply.

So given that, why is non-food inflation so high?

For non-food inflation, the issues are more difficult to identify. Inflation of the non-food
category is normally associated with growth in the realms of loose monetary policy. It is
a combination of classical moves to
reduce inflation.

Interviews by Anjuli Bhargava, Kandula Subramaniam and M. Rajendran