INFLATION FLATENED

What is Inflation?
The simple definition of Inflation is Chasing of too few Goods by too much Money. That is, there is a mismatch between circulation of Money (demand) and availability of Goods (supply). When the increase in money circulation is matched by increase in goods availability, the inflation subsides. It is obvious that in a growing economy, always money has to be spent first (by way of capital, wages, consumables, etc.) to produce additional goods and hence inflation has to be there at any point of time. But to what level and how long is a bit complex phenomenon( but not anything great that you need to be an economist to understand it). However, inflation beyond certain level, if left unchecked, will result in speculation and spiraling of prices. In a normal state of an economy (abnormal state being after big wars, after long drought / flood, after major investments in long gestation projects, etc), the inflation has a self regulating mechanism. If a particular commodity is in short supply, its price will increase in Short Term and automatically its production will increase, as more people will come farward to produce that particular commodity. Also there could be possibly some reduction in demand as well depending upon whether it is an essential commodity or not. This is called Price Elasticity. 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 with their 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 weightages assigned to each item, depending upon their importance in economy and its share in GDP. The WPI as on March 22 08 was 224.8 as against 210.11 on the same day last year, which works out to 6.997% (~ 7%) increase. We call this increase as Inflation on Point to Point basis.

Causes for long duration inflation?

As explained above, Inflation beyond normal level will correct itself over a period of time in normal course. But the time period depends upon various factors like whether the inflation is due to 1) Short supply in only few goods (or )many goods.

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 organized sector (like payment of DA / Pay Commission arrears, etc.) (or) by way of Govt. spending on direct productive investments. tion 5) Implementation of major infrastructure projects which have long gestaperiods (Large Dams, Power Projects, etc) (or) short gestation Periods. 6) Implementation of major supporting infrastructure Projects which directdo not produce any goods by themselves (like Roads, Airports, Railway Lines, etc.) Projects which contribute for direct production (like Dams, Canals, Mining, etc.) 7) Major investments in Industries which have operated at low capaci(like all PSUs which were operating at very low capacities till about 10 years 8) Short supply of imported goods over a long period (or) for a short period. 9) Short supply of Food items due to draught continuously for few years (or) one year only. (or) 10) Short supply of agricultural raw materials(Cotton, Sugarcane, Jute, etc) other raw materials. 11) Overall economic growth is by way of one or two segments of econo(or) it is due to equal growth by all segments. 12) Economy has abruptly accelerated / decelerated in a year (or) there smooth transition.

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13) Continued spending on Non-plan expenditures which do not contribute any commodity production like Defence, Service Sectors, Food Subsidy(not all subsidies), etc. to The above are a few factors responsible for inflation. In the above examples, the causes first cited will generally have longer inflation duration and the second ones will have shorter duration.

Why the Governments are so sensitive?

In developing Countries like India, people are supposed to be spending substantial part of their income for food. Whether this is true today in India is a debatable point. For any reasons, like Draught, Flood, Pest, etc (or) excessive export of food items, (or) due to hoarding of food items, if there is shortage of food items, the prices of food items will instantly soar, since food has to be bought at any cost. This will hurt the poor most lot in the society. Hence, any Government has to be sensitive to this issue. To this extent, the response of the Governments to inflation is understandable and justified whenever there are Food price increases. But in most of the occasions, the inflation is driven by factors other than the food products price increase. In fact, the weightage of primary articles (comprising mainly Food products) in WPI is hardly 22%, and hence unless there is substantial increase in their prices, the WPI will not increase. Hence, it is obvious that inflation is driven mainly by Manufactured Products and Fuel, Power, Light & Lubricants group. Given this reality, the knee jerk reactions of our Governments (and of course, the Opposition Parties) to inflation is only counterproductive. In fact, it is yet another fraud 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 Money supply and increasing goods availability. Those are listed below:

A. Reducing Money Supply:

1. Increase the Bank Deposit interest rates and encourage people to save more money. 2. Increase the Bank Loan interest rates and discourage industries/ people from borrowing more loans. 3. Increase the statutory Cash Reserve Ratio (CRR) of Banks. A part of the Deposits of all Banks shall be kept in RBI at a nominal interest rate to ensure liquidity and this is called CRR. An increase of 0.5 % ( they call it as 50 basis points - for whatever reason) in CRR today, reduces the lending amount of Banks by about Rs. 18,000 Crores.

B. Increasing Goods Availability:

1. Reduce exports by introducing Quantity restrictions, Quality restrictions, Increasing Minimum Export Price, withdrawing export benefits like ; DEPB, etc.

2. Increase imports by measures like, reducing Customs Duty, relaxing quality norms, etc. 3. Take measures to minimize hoardings by increasing interest rates for stockists on selective basis. 4. For Food articles, increase the supply from Buffer stocks through Public Distribution System.

Apart from the above standard methods there are a few other unorthodox methods also. They include changes in RBI interest rates to Banks / Governments, Budgetary changes for Plan and Non-plan expenditures, direct advice / direction by Governments to various Manufacturing Organisations to control prices, Minimum Support Price changes, etc. It is really a mystery that no one ever talks about ways and means of increasing the supply of commodities by increasing the productivity or reducing consumption by increasing Recycling / Efficiency of utilization / use of alternate commodities, etc. For example, when the Crude price has increased from USD 40 to USD 115 in the past three years, why we did not increase the Public Transport System in a big way and reduce the overall fuel consumption ? Why we did not increase the Ethanol production by increasing the Ethanol Purchase price in tandem with Crude price ? After all, we all know that, we are paying through our nose for the import of Crude Oil. When Rice / Wheat production is almost stagnant in the past 10 years, why we did not increase their Minimum Support Price (MSP) substantially to boost up their production. The rhetoric of India having achieved self sufficiency in Food is a myth. Today, India has the highest malnourished children in the world ! If the price of Rice / Wheat is very critical, why we are spending just 0.1 % of our GDP on Agricultural Research ? Instead of asking the Rice / Wheat to be sold at a cheaper price, all the Employees of Fertilizer companies can be asked to increase the productivity of Fertilizer Plants, which are running at abysmally low capacities. When Vegetable prices rise, we react so instantly. But when the tomato is thrown on the roads and Onion is left in the field itself for want of Buyers, we turn blind eye to them ! When there is shortage, we have to adjust only. Cant we reduce cooking oil consumption for a while? Why we should insist on import of Palm Oil at 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 average interest rates for loans ) enjoyed by the Banks. Actually, this is one of the reasons for higher interest rates prevailing in India, apart from causing base line inflation level. Essential Commodities price - does it really affect the so called Common 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 Jewelry shop reduces ! When we are ready to pay for Diesel / Petrol, even if it is raised by 50 % in a year, why make so much fuss when Milk price is raised by 10 % after 3 years ? For the top 50 % of our population, the fraction of their income spent on essential commodities is hardly 30 % ! Even for the bottom 30% population, with the

establishment of a strong PDS network, the fraction of their income spent on essential commodities is not more than 50%. But nevertheless, in recent years, the income disparity is increasing at an alarming rate and the bottom 30 % of the people are being pushed to the wall, especially the rural poor. For that, keeping the food prices alone cheap is not the solution. 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 Excise Duty / Sales Tax. We can not expect only the farm products to be kept at low prices all the time to help the bottom 30% people, especially when 70% of the bottom 30% population are farmers themselves ! What is tolerable level of Inflation? As explained earlier, Inflation is self regulatory, in normal course. The movement of WPI will primarily depend upon the growth rate of economy, with certain lead time, say 6 months to 1 year. Hence, the best the Government can do is keep 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. For example 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 vegetables fall? Or if the MPs march to the Parliament, will the production of Crude Oil in India will increase ? If they talk to the ONGC Employees to produce more, there is meaning 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 Government shall have a close watch and interfere. In all other cases, including Foods Products, the Government shall not interfere in the inflation, whatever may be the level. On the contrary, the Government shall always ensure that the prices of essential commodities do not fall below certain level by suitable market interventions. If a particular essential commodity price falls below remunerative price, in the next season many will opt out of its production, which will automatically cause inflation next year. Inflation Control / Remedial steps, are they justified? Whenever a particular commodity is in short supply we respond with a knee jerk reaction. Either we import or restrict exports of that commodity. When we import, 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 particular year if we stop exports, in the next year, the customer will not enter into contract with you since you are not reliable. Also, it becomes next to impossible for any Indian companies to enter into Long Term International Contracts, given this kind of Government interventions.

Another response to inflation is giving Dearness Allowance. This is totally a ridiculous step. The inflation is there because already there is excess money in the 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 supported? Secondly, by putting more money in the hands of affluent society only, we are making the vulnerable poor section of the society more vulnerable. The very 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 been the policy of Indian Governments all these years), saying that it falls under the essential commodities and all other prices are allowed to rise as per market forces, we are directly robbing the farming community to feed the non-farming community. We are transferring the hard earned wealth of the farming community to the hands of the non-farming community. When we say farming community, it includes the unorganized poor people living in rural areas, who constitute 70% of the bottom 30% of Indian population. We are indirectly saying that, as a policy, we do not want the production of essential 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 increasing the salary under the Minimum Employment Guarantee Programme or by any other means based on inflation. If you want to directly give food products, you increase their wages and give part of their wages as food products at MARKET PRICE, so that market dynamics is not disturbed. This is simple common sense. We need not read DAS KAPITAL or we all need not be Manmohan Singh to understand Inflation !

K.Periasamy, Chennai -96 ************************