Inflation rears its head: Three ways Modi govt can contain it

The story originally appeared in Firstbiz

India's wholesale price inflation hit a five-month high in May, underscoring challenges facing the new government after Prime Minister Narendra Modi warned at the weekend that he will administer "bitter medicine" to revive the ailing economy.

Modi has made controlling inflation a priority since taking office last month, but prospects of weak summer monsoon rains and turmoil in Iraq have increased the risk of rising food and fuel prices.

 Inflation rears its head: Three ways Modi govt can contain it

Prime Minister Narendra Modi. Reuters image

Inflation is indeed the biggest challenge that the Modi government is likely to face.

A JP Morgan report 'India: a policy agenda for the new government' notes that CPI inflation has averaged 9.5 percent over the last seven years underpinned by stubbornly high food inflation, which has averaged 11 percent during this period. High food inflation has often directly translated into reduced purchasing power and thereby reduced consumption. Real rural wages have slowed sharply since 2012, in part because nominal wages began to moderate, but more importantly because rural inflation spiked, dragging down real wages.

Table from JP Morgan report.

Table from JP Morgan report.

If inflation is stuck at the current levels, there's nothing much that optimism and hope can do about the economy.

So, what should the government really do to tame inflation?

Here are three advises for the government:

1. Tame cereal inflation: The report notes that the first step that the government must take is to to tame cereal inflation, which makes up almost 15 percent of the food basket. And, it seems buffer stocks aren't helping. The report notes that despite the accumulation of record buffer stocks over the last two years, cereal inflation has averaged 13%. The government needs to use buffer stocks more effectively and pre-emptively to push down cereals inflation.

2. Limit minimum support price increase: A sharp increases in MSPs in recent years have excessively incentivised farmers to produce rice and wheat, and thereby reduced the supply of other foods with stubbornly high price inflation, notes the report. Therefore, it is essential that the government limits MSPs to control inflation.

3. Reform in Agricultural Produce and Marketing Committee (APMC) Act: It's not just the cereal inflation, that is going up. Non-cereals inflation has averaged 12% over the last five years with fruits, vegetables, and high-protein items becoming particularly expensive. The key culprit behind the high prices of fruits and vegetables is the Agricultural Produce and Marketing Committee (APMC) Act.

According to the report, the act is forcing farmers to sell to government-approved agents and thereby effectively creating a monopsony at the farm gate. This has increased hoarding and price manipulation. To set fruits and vegetables free of these restrictions, the government should amend the APMC Act. However, the catch is that APMC is a state subject, and the central government will have to get states’ support for the reform.

Updated Date: Jun 17, 2014 16:08:54 IST