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What lies beneath
The Indian government mainly blames global commodity prices for
inflation, while the RBI frets about commodities, inadequate fiscal
adjustment and rising WPI-core inflation. Of course, economists blame
everyone and everything. What is often overlooked is the effect of the
broader government policy of improving the terms of trade for the
agriculture sector/rural economy that has contributed to inflation. In
recent years, the rise in food prices has significantly exceeded the increase
in the prices of non-food manufactured goods. The bottom line is that the
RBI’s tightening alone cannot deal with the multi-headed inflation devil.
In Triple-A India-Tracking the macro risks (30 March), we reiterated that
India’s inflationary pressures are a complex mix of demand- and supply-side
factors, cover food and non-food categories, and are structural and cyclical in
nature. Like the previous cycle (2004-08), global commodity prices have been
a key driver of inflationary pressures in the current cycle. However, unlike the
prior cycle, the current inflation has not been due to excessive pace of
monetary expansion. This is partly because the RBI has sensibly not been
intervening in the currency market and subsequently hiking the cash reserve
ratio (CRR) to sterilise its currency intervention.
However, far less appreciated is that the increase in food prices in recent years
has outstripped the increase in the prices of non-food manufactured goods
(Figure 1). Indeed, high inflation is partly an outcome of policy initiatives
designed to improve the terms of trade for the agriculture sector/rural economy
at the expense of the rest of India, broadly the urban middle-class.
It is often mistakenly assumed that India’s inflation is driven only by cyclical
demand pressures that higher interest rates will be able to check. While the
strength of aggregate demand, especially in the absence of the much-needed
fiscal consolidation, is a relevant contributor, there are two other factors that
are directly a function of the government’s policy: (1) higher minimum support
prices (MSPs) for several crops; and (2) higher spending on social programmes,
including the rural employment guarantee initiative. Both these policy
measures have enhanced the spending power of rural India, which, along with
structural factors resulting in greater consumerism, have contributed to the
strength of consumer demand.
Including FY05, the first year of the current Congress-led UPA coalition
government, the MSPs for wheat and rice have jumped by a whopping 75-80%
(Figure 2). In the six years to FY11, wheat and rice prices surged around 72%
and 75%, respectively, compared to the increases of around 10% and 14%,
respectively, in the six years to FY05. Thus, a meaningful part of food inflation
has been caused by the government’s own policy of higher MSPs.
In the final tally, the government’s inclusive and redistributive agenda has
favoured farmers and those in rural areas over the rest of India. In a way, high
inflation is partly the price paid by the rest of India for rural consumption
resilience. The government hopes to extract political mileage out of this profarmer approach, while others learn to live with high inflation.
What about the central bank? The RBI has correctly identified that India needs
to enhance its food supply, especially as demand increases. However, the RBI’s
interest rate hikes alone cannot fix India’s inflation woes unless commodity
prices correct and/or the government sets its policy in sync with the RBI’s
monetary tightening (see Triple-A India-Recalibration, 11 May
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
What lies beneath
The Indian government mainly blames global commodity prices for
inflation, while the RBI frets about commodities, inadequate fiscal
adjustment and rising WPI-core inflation. Of course, economists blame
everyone and everything. What is often overlooked is the effect of the
broader government policy of improving the terms of trade for the
agriculture sector/rural economy that has contributed to inflation. In
recent years, the rise in food prices has significantly exceeded the increase
in the prices of non-food manufactured goods. The bottom line is that the
RBI’s tightening alone cannot deal with the multi-headed inflation devil.
In Triple-A India-Tracking the macro risks (30 March), we reiterated that
India’s inflationary pressures are a complex mix of demand- and supply-side
factors, cover food and non-food categories, and are structural and cyclical in
nature. Like the previous cycle (2004-08), global commodity prices have been
a key driver of inflationary pressures in the current cycle. However, unlike the
prior cycle, the current inflation has not been due to excessive pace of
monetary expansion. This is partly because the RBI has sensibly not been
intervening in the currency market and subsequently hiking the cash reserve
ratio (CRR) to sterilise its currency intervention.
However, far less appreciated is that the increase in food prices in recent years
has outstripped the increase in the prices of non-food manufactured goods
(Figure 1). Indeed, high inflation is partly an outcome of policy initiatives
designed to improve the terms of trade for the agriculture sector/rural economy
at the expense of the rest of India, broadly the urban middle-class.
It is often mistakenly assumed that India’s inflation is driven only by cyclical
demand pressures that higher interest rates will be able to check. While the
strength of aggregate demand, especially in the absence of the much-needed
fiscal consolidation, is a relevant contributor, there are two other factors that
are directly a function of the government’s policy: (1) higher minimum support
prices (MSPs) for several crops; and (2) higher spending on social programmes,
including the rural employment guarantee initiative. Both these policy
measures have enhanced the spending power of rural India, which, along with
structural factors resulting in greater consumerism, have contributed to the
strength of consumer demand.
Including FY05, the first year of the current Congress-led UPA coalition
government, the MSPs for wheat and rice have jumped by a whopping 75-80%
(Figure 2). In the six years to FY11, wheat and rice prices surged around 72%
and 75%, respectively, compared to the increases of around 10% and 14%,
respectively, in the six years to FY05. Thus, a meaningful part of food inflation
has been caused by the government’s own policy of higher MSPs.
In the final tally, the government’s inclusive and redistributive agenda has
favoured farmers and those in rural areas over the rest of India. In a way, high
inflation is partly the price paid by the rest of India for rural consumption
resilience. The government hopes to extract political mileage out of this profarmer approach, while others learn to live with high inflation.
What about the central bank? The RBI has correctly identified that India needs
to enhance its food supply, especially as demand increases. However, the RBI’s
interest rate hikes alone cannot fix India’s inflation woes unless commodity
prices correct and/or the government sets its policy in sync with the RBI’s
monetary tightening (see Triple-A India-Recalibration, 11 May
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