ISSN: 1391 - 0531
Sunday February 24, 2008
Vol. 42 - No 39
Columns - The Sunday Times Economic Analysis  

The spectre of inflation will not simply go away

By the Economist

The most recent warning of the Central Bank that the rate of inflation would increase this year is more realistic than its previous assessment that it would decline gradually. Given the current rate of inflation and prospects for further increases in the prices of some items such as electricity, the most recent expectation of a further rise in inflation is more realistic. In as far as the common man is concerned, the price rises have hurt him so such that the expectation is of further increases in prices.

Statements that inflation or in the common manner of speaking that prices would decline is not taken seriously. There are sound reasons for this scepticism on the part of the ordinary man. He has been told time and again that prices would be stabilized, to find that they have actually increased. The erosion in incomes and the difficulties faced by the ordinary person is such that statistics don’t matter. Inflation has hurt poor people severely as it is the cost of basic items that have increased most. The plain fact is that the cost of living is too difficult to handle.

The spectre of inflation will not pass away easily. There are sound economic reasons why this is so. Sooner these fundamentals are understood, the more likely that we would get a hold of the inflationary pressures in the economy. As it is, it is mere hope that inflation would reach a much lower rate of around 10 percent. At best, it is an optimistic expectation and at worst it is a scant concern of the government for the poor people of the country. There are both controllable and uncontrollable factors. It is the responsibility of the government to ensure that the controllable factors are addressed.

The blame is often placed on the rise in international prices of essentials. The unprecedented rise in oil prices to reach around US$ 100 a barrel is cited as a primary cause. No doubt this was a primary reason for the rise in a number of essential items, such as petrol, diesel, cooking gas and electricity. And then these fed into a rise in food and other prices, as transport and other input costs increase. The government made a budget promise that it would hold down the price of petrol and petroleum products. This they did for sometime. Like most promises of the government, it was not a promise that it could keep for long as the subsidy to enable the control of the price became unbearable.

The short lived stable prices led to a sudden increase in prices of petrol and so the prices of domestically produced goods, as is inevitable. The Department of Census and Statistics estimated that international prices accounted for only 25 percent of the price increases in the consumer price index. By this they meant the direct increases in costs of imported items in the index. In fact, as we have pointed out earlier in these columns, the rise in import prices led to increases in domestic prices as well. The real impact of the import price increases are difficult to estimate but may in fact be much greater, say about 50 percent.

The expectation of a deceleration in prices does not take into account several factors. One of these is that inflation tends to feed upon itself. Price increases lead to further price increases. It is said that like a little bit of pregnancy there is no such thing as a little bit of inflation, for it grows. It is for this reason that western countries, and even India, are very sensitive to even an increase of a fraction of one percentage point in the index. We have got into this inflationary cycle and extricating ourselves from it is a difficult task. There are however some signs of abatement in prices of oil from current high levels. Yet, good economic management may require the benefits of this price decline not to be passed on to consumers in order to curtail consumption. This is good economics as the decrease in prices is a return to trend levels of about US $ 85 per barrel at present, but the international trend in prices would be one of rising prices. The government would have to make a hard decision whether to control consumption of oil or reduce inflationary pressures.

What's more it was doubly unfortunate that the fuel price increase coincided with a rise in prices of food internationally. The consequent inflation added to the woes of the consumer, as several commodities of daily consumption are imported. This includes wheat flour, dhal, sugar and milk. Additionally, the national misfortune was that this price rise in foods also coincided with a shortfall in rice production in the country. Hopefully the Maha harvest that is expected shortly would bring down domestic prices of rice and further imports of rice would not be needed. The performance in the Yala season would be crucial to sustain rice price stability.

The import of 75,000 metric tons of rice may have been helpful in putting a lid on rice price increases temporarily. The price of rice in the domestic market could be reduced with the benefit to the producer and consumer if an efficient purchasing system is put in place in tandem with adequate storage and milling capacity and a more competitive paddy purchasing market. The plus point is that the prevailing high prices for paddy may be an incentive for an increase in the extent of cultivation in Yala and thereby we may have a higher level of production this year, provided the weather is good.

There are the other fundamental factors about which little is said or what is stated is not stated emphatically. This relates to the fact that a fundamental reason for the inflationary pressures has been fiscal deficits over the years. These deficits have been incurred partly due to the immense war expenditure, especially in recent years. What is not realised is that deficits add to the public debt and therefore to the servicing costs of the debt. As the servicing costs of the public debt are a high proportion of public revenue and expenditure, it adds further to the fiscal deficit. This cycle is a fundamental causal factor for the continuing fiscal deficits, rising public debt and the inflationary pressures that are continuously being generated. Therefore there is a need for greater prudence in public expenditure.

If war expenditure is a must, then expenditure in other areas must be curtailed. Do we see such an effort in this direction? Definitely not. In fact one cannot escape the notion that either the government is unaware of the impact of public expenditure on inflation, insensitive to the need for fiscal discipline or plainly does not care. Whatever be the reason, unless unproductive expenditures are curtailed, the fiscal operations of the government would generate immense inflationary pressures.

This is why even with any improvement in global conditions we cannot expect to see a reduction in inflation to any significant extent. There is no doubt whatsoever that this inflationary trend would hurt investment, production, exports and the exchange rate of the Rupee. That is why fiscal discipline is of paramount importance in reducing inflation. Inflation is like a cancer in the economy that spreads all over its various economic sectors to debilitate it. Does the government realise this?

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