Should we be happy that the wholesale price (WPI) inflation number has come down to 6.6 percent in January 2013? If you are from the government, you would see it as a positive sign that inflation has finally come below the 7 percent mark – the lowest in three years!
The Reserve Bank of India (RBI) should feel even more pleased because its stance on interest rates in January was not wrong and the WPI is moving downwards; in fact, it will feel vindicated that it did the right thing at the right time. If you are a corporate, you would be happy that this is a good omen, because there could be more interest rate cuts on the anvil.
But, if you are a household, you would find little reason to feel good as consumer price inflation (CPI) has gone up by 10.8 percent during the same period, and as an individual it does not matter if core inflation has come down as we do not consume paper, leather, basic metals, iron and steel and rubber products in a significant way. These do not matter in our scheme of things. The prices of fruits and vegetables have increased substantially and no one seems to know what can be done.
Therefore, with these mixed emotions around us, what are we to make of it?
First, prices are still increasing and the pain for consumers is increasing, notwithstanding these numbers. Second, real interest rates, if reckoned on the CPI, are negative for savers and have turned positive for producers or lenders who face the WPI. Therefore, savers will lose more if banks lower their interest rates. Returns on deposits as well as investment in fixed maturity plans will come down even in nominal terms. Borrowers would, however, be better off.
The RBI will probably read this as a sign that we have moved in the reverse direction finally. After three successive years of high inflation, the rate of change in prices is coming down. The high statistical base effect, wherein a high number as base helps to lower the growth rate next year, has probably finally started to work in favour of inflation coming down. Therefore, monetary easing may be expected in future subject to the budget outcome.
The question is: are we doing anything to control prices or is it just happening naturally - through the workings of gravity? Let us look at food prices. We have had a mixed kharif harvest for staples such as cereals and pulses. The oilseeds crop has failed, which has pushed up the price of edible oils. Sugar prices continue to be high with production levels being affected in the last season. In the rabi season, while the extreme cold has helped wheat, it has affected mustard and chana, which will affect supplies and hence prices.
Add to this the phenomenon of the government increasing the minimum support prices of all crops to woo farmers (by around 10-20 percent every year), and we have laid the foundations of a high food inflation economy. The issue we have to sort out is farmer versus household. In India, there are several lobby groups, with the farmers’ lobby being quite strong. Unfortunately, there is no voice for individuals who end up paying higher prices. It is assumed almost axiomatically that farmers are poor and have to be supported while households are rich and can bear the higher price.
Another factor that affects food inflation relates to fuel prices. The government has decided to increase the price of diesel by 50 paise every month to gradually end subsidies. This is good economics but when these prices are raised, there is a direct impact on fuel prices which are presently showing an increase of just 7 percent. But higher fuel costs translate into higher transportation costs which feed into the prices of food items.
Therefore, another tough question where we have to take sides is whether we are in favour of a better fiscal deficit number or higher food prices? In fact, in the Consumer Price Index, higher fuel prices re-enter the component of transport and communication where it hits the direct incomes of households.
Under normal circumstances, one could have taken the view that inflation in such a setting has to be borne by one community and is inescapable as long as we move on the path of fiscal prudence and help poor farmers. But, food inflation has had a deep-rooted impact on consumption patterns and, as a corollary, savings. In the last year, on account of higher allocations for food, households have less to spend on non-food items which, in turn, affect demand for consumer products too. It, therefore, does not come as a surprise that this year, even during the festival season, people were not spending.
The RBI has also been concerned that financial savings are moving down, putting pressure on banks. In a situation where there is high inflation and more spending on food items, households have been moving funds to gold, which has created other kinds of problems for the government. Intuitively, whenever savings come down, the current account deficit tends to widen. It was 4.2 percent of GDP last year and could well be over 5 percent this year.
So what is the net impact? While WPI inflation coming down is a good sign from the point of view of monetary policy, we need to get our act together to bring down food prices.
First, we should halt this policy of increasing minimum support prices which are not aligned to the market, but end up driving the market instead. Second, we should resort to imports to lower the prices of edible oils and sugar in the market. These prices have tended to be sticky in the market and do not come down even when normal output is produced. Sugar was selling at Rs 20 kg before it increased sharply in 2010 to a level of Rs 40. But the price has never returned to the pre-crop failure level. Third, for horticulture, we need to cut down on wastages on a war footing to improve delivery to the store.
Inflation cannot be seen in isolation or just in the context of monetary policy. There are implications for demand and hence industrial production and savings, which finally go to affect out external account too. Therefore, while monetary policy can take a view, we have to work hard at lowering the prices of food or the situation will resemble that of a ship’s captain in the middle of s storm not knowing what to do, hoping nature will cool things down. It has already been three years now and the crew is waiting for guidance.
The author is Chief Economist, CARE Ratings. Views are personal