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Spiralling Inflation in Commodity Sector amidst decelerations: Implications and Explanations

 

By T N Jha

 

Inflation: hanging by the baloon!

Inflation: hanging by the baloon!

Conventional wisdom in development literature suggests that recession follows deflation in different measures depending upon whether it is mild or intense. In common parlance, this means, when there is contraction in growth the general price level declines, more so the commodity prices as a result of declining demand. This in ultimate analysis results into a kind of vicious circle of low demand and low investment in the economy. Inevitable consequences are increasing unemployment, low wage levels, mass poverty and further accentuation of class, regional and rural-urban divide in income distribution. Evidences, as furnished in the accompanying tables, in recent periods however reflect a picture in contrast where periods of decelerating growth showed increasing price levels. For example, the growth rate in GDP since the first quarter of 2006-07 hovered in the range of 9.3 per cent to 10.1 per cent. In all the four quarters of 2007-08, the growth remained stagnant ranging at 8.8 per cent to 9.3 per cent. It assumed the form of complete deceleration during all the quarters of 2008-09, touching the lowest growth rate at 5.3 per cent during the third quarter.

The annual rates of inflation as measured by variation in monthly wholesale price index – all commodities showed increasing trends in double digits during the first and second quarters and then started declining from November 2008 onwards, even becoming negative during the second and third quarters of 2009. One noticeable feature is that during the periods of marginal inflation and even deflation, the prices of primary articles, particularly food products mainly vegetables and fruits kept increasing, touching the level of 20 per cent rise for food products in November 2009. Since the food inflation bites more intensively, more so the poor segments the sharp inflation becomes politically and socially more sensitive and, therefore, warrants immediate policy interventions. Needless to say, the Government during this period initiated a number of policy measures, including commodity supply augmentation, checking hoardings, making intervention in the market for proper product channelling, and adopting suitable monetary policies to control and check money supply. Despite all such policy interventions food prices remained untamed and kept building pressure on overall inflation. One may argue, there is time lag in the percolation effect and materialisation of policy initiatives.  The purpose of the present paper is not to examine the adequacy or otherwise of the policy initiatives, but to simply offer some plausible explanations on the emerging scenario of the co-existence of contracting growth and rising prices in our economy and offer some suggestions on the possible road maps for checking price rise and ensuring a more balanced, stable and accelerated growth path..

As some economists and policy makers have argued, the recessionary pressures in Indian economy was the result of the melting of sub-prime market in US since the mid of 2007 and their contagion effects, more so in the financial sector. However, it has been recognised that contagion effects were mild because of lower level of global integration of our economy. The inflationary pressures on the other hand have been attributed both in the academic and policy circles to supply constraints, mainly the shortage of essential commodities. Appreciably, the Government of India initiated a number of proactive macro policy initiatives through monetary and fiscal measures as also increased plan and non plan interventions to arrest the recessionary trend and check the spiralling price rise in primary articles. A closer and deep probing of the dynamics at play in our economy reveals that there are numerous other factors which contribute more strongly to such phenomenon, but have remained unexplained in the academic as well as policy circles.

First and foremost reason could be traced in the ever increasing size of the unaccounted economy, which keeps greasing the demand with all pervasive presence, despite shrinkage in the accounted sector. Even the conservative estimates put the size of unaccounted economy which was one-third of GDP in early nineties to almost one-half by now. The ever increasing presence of such economy, while some may argue, offers cushions against recessionary shocks and may even attribute milder recession to this, one must not forget that the monster may have crippling effects as far as it negates a more efficient and optimal utilization of scarce resources and at the same time denies equitable distribution of income. In fact, much of the skewed income distribution in India could be attributed to this; as such economy admittedly is biased and ignores the unorganised and real sectors to a large extent. Moreover, it defies regulations and efficient channelling of investments. Perhaps, much of the rural- urban divide in shining India could be traced to the unchecked and uncontrolled regime of unaccounted sector.

Another plausible explanation for the contrasting scenario could be seen in the financial sector reform packages that have been offered to financial institutions and farmers through debt waiver schemes and institutional revival packages, mainly co-operatives. The combined financial support under such packages has exceeded Rs 1.50 lakh crores, which comes to nearly 10 per cent of the union budget and nearly 2 per cent of the GDP. While such packages of support has time lag in inducing and augmenting commodity production and hence the income and employment growth, it has certainly enhanced the financial liquidities in select sectors, thus fuelling demand and pushing up inflationary pressures. Although the Reserve Bank of India through various monetary measures and policy instruments from time to time has been checking and balancing  the liquidities, it may however be admitted that coverage of such measures weakens when it comes to rural sector. This is not taken to question whether such a package of support is desirable or not, but simply to suggest that the quantum of such support packages should have been determined on the basis of some assessment of the inflationary impact  such packages might have induced.

Third, it may be recognised that the inflationary pressure is more on account of rising food prices. Comparing the price movement at retail and wholesale levels, some economists have argued that the rising food prices is on account of distribution failures rather than supply shortages or reduced productions. This is concluded on the basis of the evidence that price movements of food articles have increased much more significantly at retail level than wholesale level. However, one must not forget that hoardings of food articles, mainly cereals, pulses and vegetables like onion and potatoes mostly by private traders have also constrained the timely supply of these articles, thus artificially creating demand- supply mismatches and building upward pressures on commodity prices. More important, the large scale hoarding also leads to increase the accumulations in the unaccounted sector. The failure of the public distribution system on occasions to make accurate assessments of the market demand and sentiments and making timely interventions by releasing the required stocks could also accentuate the push forces and built up pressure on the prices of food articles.

Fourth, the intervening periods also witnessed large scale jump in fiscal support of public programmes for creation of employment opportunities and production of goods and services, mostly social and economic infrastructures. The implicit objectives behind such initiatives have been to augment the demand. The stipulated wage rates coupled with the emphasis on universal coverage, particularly among the targeted groups meant large scale fund flows in the rural sector. Studies have shown that these programmes have enhanced income and employment opportunities in the rural segments. Given the high income elasticity of demand and positive influence of increased income on changing the consumption compositions, more in favour of non-cereal products, such a large fund flows might have augmented commodity demand. One may argue that since the BPL families are covered under public distribution system at cheaper rates, such fund flows might not have fuelled commodity demand. It may be mentioned that the basket of food articles constitutes vegetables and fruits as well which the PDS system does not cover through their distribution network. As the NSS data show, with rising income the share of non- cereal articles among food consumption basket increases. Evidence also suggests that while the share of food in total consumption has declined across different classes of population, including the poor, the consumption of vegetables, fruits, milk egg, meats, etc has become income neutral. This simply means, even the population belonging to lower income brackets have started consuming such food articles, thus enhancing the demand for such products. With increased income and employment opportunities, as induced by public sponsored programmes, the demand push for such food products also seems to have built inflationary pressures.

Fifth, the psychological impact that the delayed monsoon created on the market sentiments both from supply and demand side also contributed to build inflationary pressures on the primary articles. It may be recalled that the delayed and finally the inadequate rainfall in the Gangetic plains, which due to high demographic pressures also happens to be the largest chunk of consumers suffered large production losses of food articles except parts of western regions, which despite erratic and lower rainfall could save the crop due to efficient canal irrigation system. The production loss was more for non-cereal articles like vegetables, milk, meat, etc. On the demand side, future expectations of continued short supplies, coupled with rising commodity prices led to chasing of commodities by consumers and even making hoardings, may be in small and fragmented quantities at private farm levels by postponing immediate disposal of farm produce. Ultimately, such a phenomenon created large mismatches in the demand and supply of such commodities, leading spiral effects on their prices. The case of milk and meat sector was still worse, as there were extensive damages to livestock sector caused by shortages in the feed and fodder due to the failures of monsoon. Evidence suggests that in the event of production failures or shortages the commodity demand gets abnormally pushed up for fear of still higher rise in prices. This certainly warrants suitable policy interventions which could influence more efficient management and control of commodity demand, both at micro and macro levels to supplement other measures of checking inflationary pressures. While the Government through various price and non-price policy initiatives have sought to check inflationary pressures, management and control of commodity demand remained quite passive. For example, abstention from consumption of a specific commodity showing high price sensitivities in times of shortages may pull down the demand pressure. This needs some kind of building social awareness through various mass awareness building programmes. Besides, changing consumption basket by adoption of substituting commodities may also ease demand pressure. Much of the problem could also be seen in the fact that we have a fixed set of consumption basket. Changing such consumption basket may also have smoothing effect on the demand pressure. However, policy initiatives hardly recognised such dimension of inflation, may be because of political sensitivities.

The list of factors inducing spiral food inflation as enumerated above is not exhaustive. There could be a few more explanations. However, the evidences and analytical framework as offered above do amply suggest that the volume of stimulus packages, coupled with large flow of incentives offered to farmers under debt waiver scheme, and to financial institutions under revival packages, failure to make proper assessment of the market sentiments, lager presence of government programmes in the rural sector, non appreciation of demand management in policy circle as price smoothening variable, and above all  ever increasing presence of unaccounted sector contributed significantly in abetting commodity demand, and building inflationary pressures. Any policy initiative aimed to control and rein in inflation would involve consideration of these policy variables as well.

Variations in Monthly Wholesale Prices Base:1993-94

Year Months All Commodities Primary Articles Food Articles Fruits and Vegetables
Index Annual Variation (%) Index Annual Variation (%) Index Annual Variation (%) Index Annual Variation (%)
2008 January 218.1 4.45 224.6 4.85 219.7 2.09 218.5 0.18
  February 219.9 5.26 230.6 7.25 222.1 3.35 220.3 0.18
  March 225.5 7.48 235.9 9.92 226.7 5.93 236.1 4.70
  April 228.5 8.03 238.6 8.50 230.4 5.54 245.4 7.40
  May 231.1 8.85 241.9 9.50 233.2 5.71 252.7 9.34
  June 237.9 11.82 243.9 10.56 232.3 5.93 241.4 1.47
  July 240.0 12.35 248.7 10.78 236.6 6.00 252.0 5.00
  August 241.2 12.81 249.3 11.39 237.9 6.92 255.1 5.76
  September 241.5 12.27 252.2 11.60 242.9 7.72 276.0 6.68
  October 239.0 11.06 251.2 12.24 245.5 9.94 277.0 14.32
  November 234.2 8.48 250.9 12.06 246.0 10.31 278.4 18.92
  December 232.3 7.1 247.3 11.15 242.0 9.95 272.1 17.92
2009 January 228.9 4.59 248.6 10.68 243.9 11.01 256.2 17.25
  February 227.6 3.50 246.4 6.85 242.9 9.37 241.3 9.53
  March 228.2 1.20 248.2 5.24 243.8 5.82 240.9 2.03
  April 231.5 1.31 254.4 6.62 250.2 7.29 271.1 10.47
  May 234.3 1.38 257.2 6.32 252.9 8.87 272.2 7.72
  June 235.0 1.01 259.8 6.52 257.6 8.88 274.0 13.50
  July 238.7 (-)0.50 267.7 8.44 270.1 13.54 294.7 16.94
  August 240.8 (-)0.16 269.2 10.19 271.4 11.73 285.7 12.00
  September 242.6 (-)0.45 273.4 8.40 277.4 14.20 305.8 10.80
  October 242.5 (-)1.46 273.4 8.80 277.4 13.00 294.9 6.46
  November 247.2 5.55 285.9 13.95 291.9 18.69 318.5 14.40
  December 246.5 4.8 287.1 16.09 290.5 20.04
2010 January 248.5 8.56 284.7 14.52 286.4 17.43 277.5 8.31
  February 250.1 9.90 284.7 15.54 286.1 17.78 273.0 13.14

Sectorwise Quarterly Estimates of GDP at Factor Cost-  % Annual Growth Rates

Years Quarters Sectors
Agriculture & Allied Industry Services Total GDP
2006-07 Q1 2.7 10.8 11.5 9.6
Q2 3.2 11.0 11.5 10.1
Q3 4.0 10.4 11.1 9.3
Q4 4.9 11.6 10.3 9.7
2007-08 Q! 4.4 9.1 11.0 9.2
Q2 4.7 9.4 10.5 9.3
Q3 6.0 8.2 10.4 8.8
Q4 2.9 7.6 10.4 8.8
2008-09 Q1 3.0 6.9 11.2 7.9
Q2 2.7 6.1 10.0 7.6
Q3 (-)2.2 2.4 9.7 5.3
Q4 2.7 1.4 7.8 5.8
2009-10 Q1 2.4 5.0 7.8 6.1
Q2 0.9 8.3 9.3 7.9

 

 

Note on author: Dr T N Jha is the Chairman, Indo-Nepal Friendship Trust, Patna

 

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