ISSN: 1391 - 0531
Sunday, July 29, 2007
Vol. 42 - No 09
Columns - The Sunday Times Economic Analysis  

Talks of change have no effect on infiltrated inflation

By the Economist

There is a continuing optimism in the Central Bank that inflation will go away. Whatever be the current rate of inflation the prediction is that there would be a downtrend shortly. The common man who faces the reality of increasing prices day-in-day-out can hardly be convinced with whatever the statistics are and however these are interpreted. The fact is that rice, bread, dhal and all kinds of vegetables costs him so much more than a year ago. Cooking gas prices have risen, bus fares have increased and exercise books for school children have risen and are rising. There is nothing he can think of as having had relatively stable prices. Paradoxically the war that is one of the important causes of the inflation is also the factor that makes many people endure the hardships in the name of patriotism and on the other hand, in the hope that there would be an end to war and terror and that happy times would be here again. This is why the opposition has largely failed to whip up ill feeling for the government in the face of the large increases in prices in the last year. The recapture of the East and the prospect of victory in the war are the opium of the masses.

According to the Central Bank, inflation has decelerated from 13.7 percent in May to 13 percent in June. The Bank admits that July would be a bad month as many prices of goods have increased already. However such price increases are expected to be “temporary” and inflation is predicted to reduce next month (August). How can one be certain of that? Surely oil prices are likely to rise, the currency is likely to depreciate and international prices of many commodities that enter domestic consumption or inputs into production are likely to increase? Yes, but the Central Bank takes refuge in the fact that these increases would not be as high as it has been in July.

There is a further reason why the Central Bank expects a deceleration. The foreign exchange reserves are expected to rise with further borrowing. This is expected to strengthen the rupee and therefore keep the trend of rupee depreciation that we have witnessed in check. Besides this, the rise in prices of imported goods has resulted in a reduction of imports. In the first five months of the year imports increased by only 7.5 percent. This modest increase in imports compared with a 14.4 percent increase in exports would also reduce the trade deficit and reduce the strain on the balance of payments. In the first five months the trade deficit decreased by 4 percent. The other good news is that remittances from abroad are increasing and giving significant support to the balance of payments. Remittances increased by 17 percent in the first five months of the year compared to the same period last year to reach US $ 1086 million. These factors resulted in a balance of payments surplus of US $ 192 million in the first six months of the year till June.

One needs to place these economic facts in perspective. A common confusion is between the rate of increase or deceleration in prices that has to be juxtaposed with the reality of rising prices. This leads many to be sceptical of the statistics. The fault lies not in the statistics themselves but in their interpretation. When the price index shows a deceleration in prices it does not mean that prices have come down. All that it signifies is that the rate of increase has abated. Prices are rising but not at the same rate as before. Therefore the consumers’ common experience that prices are rising is not inconsistent with the deceleration in the price indices. What the index indicates is that prices have risen though not at the same rate as before.

The other misinterpretation arises as price increases are on top of the earlier price increases. For instance if the price of a basket of commodities rose from Rs.1000 to Rs.1200 in January it is a 20 percent increase. Then if prices rise by a further 10 percent in February it is a deceleration of prices. Yet the cost of the basket has increased by a further 10 percent and now costs Rs.1320. The average of the price increases for the 12 months of the year provides one an estimate of price rises for the year that is generally described as the rate of annual inflation.

To confuse readers further there is the point to point increase in prices that is generally quoted. This is for instance the prices at the end of July compared to the prices at the end of July in the previous year. Sometimes this comparison could be deceptive. If the prices at the end of the month in previous year were high then the rate of increase would be lower that what the consumer feels in comparison with recent months. This is particularly so when there are wide fluctuations in prices. However the point to point estimates of price increases has the merit of recognising seasonal price changes and therefore irons out seasonal fluctuations in prices. A good example would be that if one compares the prices between December and May the latter may be lower due to at least two reasons. December is a seasonally high price month owing to the festivities and higher demand particularly for certain food items, while April, May are months when the harvest is gathered and therefore prices decline. This is particularly so in the case of rice prices.

The increases in prices are due to fundamental reasons, the most fundamental being the increasing fiscal deficit caused by the increases in the costs of the war, the increasing costs of debt servicing, the massive expenditure on public service salaries and the expenditure on an obese cabinet. Unless and until public expenditure is brought in line with government revenue the increasing trend in prices will continue.

Some of the inflationary pressures would also be from increasing international prices of imports, especially oil. The depreciation of the currency that is also linked to the increase in expenditure on the war and the servicing of the foreign debt will also continue to exert upward pressures on domestic prices. The even more regrettable factor is that these factors would be contributing to future inflationary pressures as well. Further the Central Bank’s tight monetary policies are hurting production in an environment that is in any case not conducive to investment.

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