Inflation is back on the government agenda with a bang. This is natural. What is unusual is the scale and speed of rise in the inflation numbers. In the course of just five weeks or so, the wholesale price based inflation not only breached the comfort level of the target projected by the RBI, namely, four to five per cent, but surged to threaten the almost eight per cent hurdle. Going by the recent trend between the provisional and final numbers, the margin may be in excess of a half percentage point. In effect then, the wholesale price based inflation is already hovering near eight per cent. This has happened after the mid-nineties. Was it unexpected? In an article (Mainstream, February 17, 2007) I had analysed the surge a year ago and concluded thus: “The current inflation is not going to fade away easily and on its own.”
Why has this conclusion proved realistic? The government has easy justification of “the phenomenon of imported inflation”. That implies two things. Firstly, we were aware of the evolving global scenario and yet missed the opportunities for preventive steps in time. Secondly, we are not shielded from the downside of the external sector-led growth strategy so that we are now being hurt. This hurt is self-inflicted. If this is the case, then there is a grievous policy failure. The government has knowingly ignored the global signals of the gathering storm. The Finance Minister has been repeatedly reminding us that our economic and financial fundamentals were strong and the global financial turmoil and economic imbalances in the commodity markets would not influence our economy much. Even now, there are symptoms of ad hoc actions and not any long-term strategy to deal with the backlash of financial globalisation.
Structural Shift
IN taking the risk of rapid globalisation there was the need for a rapid response to the shifting structural base of globalisation. This is seen, in the first place, in growth at the cost of all other concerns inbuilt in the economy. These relate to growing regional differentiation in contribution to growth, strong linkages between investment and consumption in a fragmentary social milieu and, therefore, concealed sources of price surge as between sectors of the economy. Growth cannot be divorced from the inherited imbalances of the past to which new ones have been added. Divorce between domestic focus on the potentials of the hinterland and immediate returns from disproportionate investment in the advanced coastal States is now more pronounced than ever before. Secondly, the Finance Minister has claimed frequently that high prices are natural when the economy had taken to a high growth trajectory. However, the government seems to have ignored the need to work out a more balanced trade-off between inflation and growth that could have been less painful than the current inflation surge. For almost two years now there was apparently a divided view about what should be done as between the government and the RBI. As a result, the benefits of collaborative scales as between monetary and fiscal steps were missing.
Thirdly, as late as his 2008 Budget speech, the Finance Minister emphasised that the driving forces behind growth are manufacturing and service sectors. I have repeatedly questioned the appreciating fiscal incentives to the service sector ahead of the needed incentives for the primary and secondary productive sectors. The crucial role of the primary sector in providing stability to growth and moderating inflation is now fully exposed. Fourthly, little concern is seen for the social consequences of the budgetary exercise for strengthening dependence on the country’s fragmented market to respond to sensitive economic concerns. The current tussle between government and industry on the pricing of steel and cement or protecting escalating input costs exposes the weakness of the strategy pursued. The public sector functioning only as stepny does not seem to match our needs yet. Finally, the consequences of the creeping change in the structure of the global economy with Asia and the former communist economies denting the preponderance of the old world economy in swinging the trade and business cycle remains to be integrated in the policy direction. Repeated emphasis on prices of commodities going up in the global market ignores to take into account that this is happening from the addition of the food, metal and fossil fuel needs of Asia to the total pool. Protecting prosperity for the minority has its adverse consequences for the rest. This political dimension is what must haunt a democratic government.
Contributors to Price Rise
THE government’s explanation that the present spurt in prices is from primary commodities needs to be taken with a pinch of salt. If that were really so, the country or parts of it should have witnessed scarcity protests and riots. That is not happening. The metro and urban area supply chains are functioning well physically. And if the high prices of the food commodities of daily use are giving farmers better returns, then that is only fair and is to be welcomed. But that is exactly what is not happening. The large retail chains, so assiduously promoted by the government, have not produced the needed moderation in prices. The spurt in prices is, therefore, from rising incomes that we are proud to flaunt. It is from the growing tendency among the small minority of consumers to engage in what the mainstream media joins in “splurging”. It signifies conspicuous consumption straining the supply chain. Did not the Finance Minister, while defending changes in the income tax slabs, state that half the gains should go in spending? Again, despite the monetary tightening by the RBI, growth rates are expected to remain at a respectable level. There is month-to-month fluctuation so far for which reasons have to be gone into closely. One view is that black money is sustaining the high growth rates now! So, inflation has a good companion in black money.
The mainstream media screams that food prices have led to higher rates. Is that for real? Eighteen per cent of the GDP has overshadowed the remaining? A deeper analysis shows that food inflation in India is lower than manufacturing inflation taking a year as reference. In terms of global comparison, food inflation in India is six to seven per cent while it is much higher outside. It is also significant that imports are an insignificant portion of food commodities in the market. On the other hand, manufacturing and some segments of the service industry source raw materials through imports. Obviously, when input costs are advanced for increasing prices this is essentially for sectors that are engaging in imports on public explanation of lower costs. If that is so, why is it manufacturing inflation at all? But factually, going by the need to even import bulk commodities such as coal and the surge to acquire assets abroad corporate profits have to go up. Larger fuel price inflation has been contained only because of government subsidy, largely to protect the industry. Has not the Budget reduced excise duty on some automobiles even while crude prices have surged beyond $ 110? The globalised economy is not necessarily a low cost economy. Let us be clear that economic policy is after the high cost-high spending economy. Managers of the economy should, therefore, defend that policy rather than pass the blame on the primary sector or the farmers. Failure on controlling inflation lies in this success of the neo-liberal economic policy. Growth versus Inflation
IT is owned that high growth puts pressure on prices. High growth and higher profits place pressure on sharing the benefits with manpower. The employment data shows that wages of workers are not adequately adjusted even to the level of real productivity gains. However, managerial remuneration is inflated on the ground of skill shortage. The structure of such employment is changing too. Consultancy is gaining in importance in preference to the core sectors of the economy. The government itself is providing a signal through practices that encourage this trend. Add to this cheap loans for expanding consumption, the push for unplanned urban expansion without it contributing to core urban infrastructure, stress on white goods without adequate and quality supply of electricity despite the new love for private distribution and a plethora of incentives that impact prices in general. Overall, the economy is becoming a high-cost, high-consumption economy that domestic production has not received the incentives to sustain. So, imports surge in both segments, namely, intermediate raw material and finished products. The foremost real contributors to price rise are manufacturing, high-tech services, spending-intensive foreign tourism and travel and the like. The bulk of the population can only watch. And suffer.
Food prices have responded because of critical support required from the manufacturing and service industries. However, we have not yet reigned in the middle man directed marketing chain. The farmer’s share in higher prices is small. Agricultural inputs’ prices have gone up consistently. Fertiliser subsidy is one indication of how both domestic and imported prices produce the impact. The perpetually adverse balance of trade numbers is another indication that foreign trade would be unmanageable without a growing surge of remittances of Indians working abroad and without the surge in FII-trading in stocks. Most trading in stocks and in foreign capital management and trade have a tendency to add to inflation more than food prices. In fact the price data that forms the basis of projecting food price inflation has a very narrow footing. First, the weightage of food is very small; manufacturing is the dominant partner. Secondly, consumer price inflation is still running neck-to-neck with wholesale inflation. Thirdly, the frequency of the wholesale inflation reporting can work with an efficient data monitoring system. That is lacking. The private trade data is suspect too since wholesale prices provide the rationale for low interest loans to manufacturing, export sector and industries located in tax-concession zones. In effect it is not a true indicator of cost and profit. All this adds to the woes of food sector pricing. The management of capital flows and price and the inherent profitability levels of the industrial sectors are larger contributors to inflation.
A broader policy framework to remove distortions in the total production to the marketing chain will impact the current incentive structure in the economy. The inflation priority would involve curtailment of the profit margins in the chain. It will have consequences for stock prices and suppressed asset bubbles. This is a risk for growth that the government puts premium on despite the distribution of growth being socially perverse. A state of confusion serves policy-making best in the circumstances. Whether it is in the long term interest of the economy is a different matter. Failures of Policy?
WHO is to blame for the current bout of inflation? The major blame must lie with policy-making that did not factor in the social consequences of growing differentials between incomes, domestic availability of goods and services and surge of “fashionable consumption”. Population groups that contribute to such consumption are a minority but they have the potential not to be socially responsible. Consumption promotion is at the root of the high growth trajectory and concessions in rates and taxes as also duty for import of fancy products, including dog’s food, are adjusted accordingly. Lately, the talk of investment-led growth justified the surge in consumption too. The high point of policy is aggregate growth rate to the exclusion of commensurate welfare. It is ignored that growth is a poor measure of economic prosperity when the economy remains fragmented, regional disparity is rampant and social contribution rigidly segmented. Finally, much reliance is devoted to putting down lending rates artificially to keep these comfortable for the favoured classes. In sum, then, the current phase is an outcome of political complacency about the “good times” never ending.
The basic food staples price has to be seen in the perspective of the last two-three years. This increase has been in the range of 30 per cent plus. Wages, neither on public works nor in private employment, have seen that level of increase. So inflation affects the level of essential consumption of the poor harshly. They cut their consumption to the utmost level. The bulk of foreign remittances by Indians also goes into meeting the deficits in consumption of this hard-pressed group. So, high prices reflect a structural shift in the share of consumption between social groups. The economist’s thesis that with increasing aggregate per capita income, the population necessarily shifts to high value foods is a myth. Inflation has a social bias in hurting: it hurts the economically weak disproportionately. That is the whole debate about the politics of inflation. That is at the root of linking the debate to the proximity of elections and the fortunes of rulers.
It has been proved that the high prices of essential commodities have led to the loss of elections by ruling parties at the Centre. Its Leftist allies are the principal advocates of improving the public delivery of staples and some other essential commodities of mass consumption. Instead, there has been reduction in the targeted allocations to States in the last two years on the basis of one or the other technical considerations. The refrain in the government is that everything possible is being done. Administrative and fiscal measures taken in a whole year have not delivered. That is a poor perception of how politics works. It is more so in our country since no mechanism for working out a strategy by involving political parties across the board exists. Neither the ruling coalition nor the Opposition is interested in such an exercise. So, politics will play itself out while the common people bear the brunt of rising inflation.
A last word about the actual level of inflation may be in order. The past is under attack by the new liberalisers. But in more than a decade-and-a-half of the so-called economic reforms, it has not been possible to establish a new basis for measuring inflation and its social impact on the common people. As it appears, the inflation might be hovering near eight per cent now at the wholesale level. The consumer inflation might have topped that by now. In this respect, at least, we have caught up well with China. Since we are being fed much about the global food scenario influencing domestic prices even after export ban, import liberalisation and subsidies, it is necessary to look at the food security scenario anew. The controversy about futures in food trade is still raging. The Economist of London dwells on the “tsunami of hunger”. The New Statesman examines how the “rich starved the world”. The Washington Post examines the “politics of hunger”. That needs to be looked at closely in the perspective of our national economic policies.
The author, a distinguished administrator, is a former Chief Secretary of Bihar (now retired).
Thursday, September 11, 2008
Inflation tackle
Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for policy framers.
The natural fallout of this has been that we, as a nation, have become virtually intolerant to inflation. While inflation till the early nineties was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly.
Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes.
Needless to emphasise, causes of today's inflation are complicated. However, it is indeed intriguing that the policy response even to this day unfortunately has been fixated on the traditional anti-inflation instruments of the pre-liberalisation era.
Global imbalance the cause for global liquidity
To understand the text of the present bout of inflation, let us at the outset understand the context: the functioning of the global economy, which is in a state of extreme imbalance. This is simply because developed western economies, particularly the United States, are consuming on a massive scale leading to gargantuan trade deficits.
Crucially their extreme levels of consumption and imports are matched by the proclivity, nay fetish, of the developing countries in having an export-driven economic model. Thus while a set of developing countries produces, exports and also saves the proceeds by investing their forex reserves back in these countries, developed countries are consuming both the production and investment originating from the developing countries.
In effect, developing countries are building their foreign exchange reserves while the developed countries are accumulating the corresponding debt. After all, it takes two to a tango.
For instance, the US current account deficit is estimated to be 7 per cent of GDP in 2006 and stood at approximately $900 billion. Obviously, the current account deficit of the US becomes the current account surplus of other exporting countries, viz. China, Japan and other oil producing and exporting countries.
The reason for this imbalance in the global economy is the fact that after the Asian currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive devaluation.'
Under this scenario, many countries simply leveraged their weak currency vis-�-vis the US dollar to gain to the global (read US) markets. This mercantilist policy to maintain their competitiveness is achieved when their central banks intervenes in the currency markets leading to accumulation of foreign exchange, notably the US dollar, against their own currency.
Implicitly it means that the developing world is subsidising the rich developed world. Put more bluntly, it would mean that the US has outsourced even defending the dollar to these countries, as a collapse of the US currency would hurt these countries holding more dollars in reserves than perhaps the US itself!
In this connection, commenting on the above phenomenon in the Power and Interest News Report, Jephraim P Gundzik wrote that the world growth "was hardly sufficient to be behind the further rise of commodity prices in the first five months of this year (i.e. in 2006). Rather than demand pushing the value of commodities higher in the past 18 months, it has been the (impending) dollar's devaluation against commodities that has pushed commodity prices to record highs."
Naturally, as the players fear a fall in the value of the dollar and reach out to various assets and commodities, the prices of these commodities and assets too will rise.
The psychological dimension
But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between central banks and the psychology of market players across continents.
As a corrective measure, economists are coming to the conclusion that most of the currencies across the globe are highly undervalued vis-�-vis the dollar, which, in turn, requires a significant dose of devaluation. For instance, a consensus exists amongst economists and currency traders that the Yen is one of the most highly undervalued currencies (estimated at around 60%) along with the Chinese Yuan (estimated at 50%) followed by other countries in Asia.
This artificial undervaluation of currencies is another fundamental cause for increasing global liquidity.
To get an idea of the enormity of the aggregation of these two factors on the world's supply of dollars, Jephraim P. Gundzik calculates the dollar value of rising prices of just one commodity -- crude oil.
In 2004, global demand for crude oil grew by a mere four per cent. Nevertheless higher oil prices advanced by as much as 34 per cent. Consequently, it is this factor that significantly contributed to increase the world's dollar supply by about $330 billion.
In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by only 1.6 per cent. Nonetheless, the world's supply of dollars increased by a further $460 billion.
Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While one is not sure as to whether the increase in the prices of crude led to the increase of other commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led to the increase in commodity prices as a whole.
Although some of this increase in the world's supply of dollars has been reabsorbed into US economy by the twin American deficits -- current as well as budgetary -- it is estimated that as much as $600 billion remains outside the US.
What has further compounded the problem is the near-zero interest rate regime in Japan. With almost $905 billion forex reserves, it makes sense to borrow in Japan at such low rates and invest elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be approximately $200 billion -- has undoubtedly found its way into the asset markets of other countries.
Most of it has been parked in alternative investments such as commodities, stocks, real estates and other markets across continents, leveraged many times over. Needless to reiterate, the excessive dollar supply too has fuelled the property and commodity boom across markets and continents.
The twin causes -- excessive liquidity due to undervaluation of various currencies (technical) and fear of the US dollar collapse leading to increased purchase of various commodities to hedge against a fall in US dollar (psychological) -- needs to be tackled upfront if inflation has to be confronted globally.
Higher international farm prices impact Indian farm prices
What actually compounds the problem for India is the fact that lower harvest worldwide, specifically in Australia and Brazil, and the overall strength of demand vis-�-vis supply and low stock positions world over, global wheat prices have continued to rise.
Wheat demand is expected to rise, while world production is expected to decline further in the coming months, as a result of which global stocks, already at historically low levels, may fall further by 20 per cent. These global trends have put upward pressure on domestic prices of wheat and are expected to continue to do so during the course of this year.
No wonder, despite the government lowering the import tariffs on wheat to zero, there has been no significant quantity of wheat imports as the international prices of wheat are higher than the domestic prices.
Growth and forex flows
Another cause for the increase in the prices of these commodities has been due to the fact that both India and China have been recording excellent growth in recent years. It has to be noted that China and India have a combined population of 2.5 billion people.
Given this size of population even a modest $100 increase in the per capita income of these two countries would translate into approximately $250 billion in additional demand for commodities. This has put an extraordinary highly demand on various commodities. Surely growth will come at a cost.
The excessive global liquidity as explained above has facilitated buoyant growth of money and credit in 2005-06 and 2006-07. For instance, the net accretion to the foreign exchange reserves aggregates to in excess of $50 billion (about Rs 225,000 crore) in 2006-07. Crucially, this incremental flow of foreign exchange into the country has resulted in increased credit flow by our banks. Naturally this is another fuel for growth and crucially, inflation.
This Reserve Bank of India's strategy of dealing with excessive liquidity through the Market Stabilization Scheme (MSS) has its own limitations. Similarly, the increase in repo rates (ostensibly to make credit overextension costly) and increase in CRR rates (to restrict excessive money supply) are policy interventions with serious limitations in the Indian context with such huge forex inflows.
How about the revaluation of the Indian Rupee?
To conclude, all these are pointers to a need for a different strategy. The current bout of inflation is caused by a multiplicity of factors, mostly global and is structural. Monetary as well as trade policy responses, as has been attempted till date, would be inadequate to deal with the extant issue effectively.
Crucially, a stock market boom, a real estate boom and a benign inflation in the foodgrains market is an economic impossibility.
It has to be noted that the Indian market is structurally suited for leveraging shortages rather effectively. Added to this is the information asymmetry among various class of consumers as well as between consumers, on the one hand, and producers and consumers, on the other.
Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world, has fuelled the rise of the stock markets and real estate prices in India to unprecedented levels.
This boom has naturally led to corresponding booms in various related markets as much as the increased credit flow has in a way resulted in overall inflation.
Economic policy rests in the triumvirate of fiscal, monetary and trade policies. Theoretical understanding of economics meant that these policies are interdependent.
Also, one needs to understand that growth naturally comes with its attendant costs and consequences. While these policies are usually intertwined and typically compensatory, one has to understand that the issues with respect to inflation cannot be subjected to conventional wisdom in the era of globalisation.
One policy route yet unexamined in the Indian context by the government is the exchange rate policy, especially revaluation of the Rupee as an instrument to control inflation.
It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex issue of managing inflation, while simultaneously address the constraints on the supply side on food grains through increase in domestic production.
A higher Rupee value vis-�-vis the dollar would mean lower purchase price of commodities in Rupee terms. The Indian economy has undergone significant changes in the past decade and a half. With increased linkages to the global economy, it cannot duck the negatives of globalisation.
The natural fallout of this has been that we, as a nation, have become virtually intolerant to inflation. While inflation till the early nineties was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly.
Inflation today is caused more by global rather than by domestic factors. Naturally, as the Indian economy undergoes structural changes, the causes of domestic inflation too have undergone tectonic changes.
Needless to emphasise, causes of today's inflation are complicated. However, it is indeed intriguing that the policy response even to this day unfortunately has been fixated on the traditional anti-inflation instruments of the pre-liberalisation era.
Global imbalance the cause for global liquidity
To understand the text of the present bout of inflation, let us at the outset understand the context: the functioning of the global economy, which is in a state of extreme imbalance. This is simply because developed western economies, particularly the United States, are consuming on a massive scale leading to gargantuan trade deficits.
Crucially their extreme levels of consumption and imports are matched by the proclivity, nay fetish, of the developing countries in having an export-driven economic model. Thus while a set of developing countries produces, exports and also saves the proceeds by investing their forex reserves back in these countries, developed countries are consuming both the production and investment originating from the developing countries.
In effect, developing countries are building their foreign exchange reserves while the developed countries are accumulating the corresponding debt. After all, it takes two to a tango.
For instance, the US current account deficit is estimated to be 7 per cent of GDP in 2006 and stood at approximately $900 billion. Obviously, the current account deficit of the US becomes the current account surplus of other exporting countries, viz. China, Japan and other oil producing and exporting countries.
The reason for this imbalance in the global economy is the fact that after the Asian currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive devaluation.'
Under this scenario, many countries simply leveraged their weak currency vis-�-vis the US dollar to gain to the global (read US) markets. This mercantilist policy to maintain their competitiveness is achieved when their central banks intervenes in the currency markets leading to accumulation of foreign exchange, notably the US dollar, against their own currency.
Implicitly it means that the developing world is subsidising the rich developed world. Put more bluntly, it would mean that the US has outsourced even defending the dollar to these countries, as a collapse of the US currency would hurt these countries holding more dollars in reserves than perhaps the US itself!
In this connection, commenting on the above phenomenon in the Power and Interest News Report, Jephraim P Gundzik wrote that the world growth "was hardly sufficient to be behind the further rise of commodity prices in the first five months of this year (i.e. in 2006). Rather than demand pushing the value of commodities higher in the past 18 months, it has been the (impending) dollar's devaluation against commodities that has pushed commodity prices to record highs."
Naturally, as the players fear a fall in the value of the dollar and reach out to various assets and commodities, the prices of these commodities and assets too will rise.
The psychological dimension
But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between central banks and the psychology of market players across continents.
As a corrective measure, economists are coming to the conclusion that most of the currencies across the globe are highly undervalued vis-�-vis the dollar, which, in turn, requires a significant dose of devaluation. For instance, a consensus exists amongst economists and currency traders that the Yen is one of the most highly undervalued currencies (estimated at around 60%) along with the Chinese Yuan (estimated at 50%) followed by other countries in Asia.
This artificial undervaluation of currencies is another fundamental cause for increasing global liquidity.
To get an idea of the enormity of the aggregation of these two factors on the world's supply of dollars, Jephraim P. Gundzik calculates the dollar value of rising prices of just one commodity -- crude oil.
In 2004, global demand for crude oil grew by a mere four per cent. Nevertheless higher oil prices advanced by as much as 34 per cent. Consequently, it is this factor that significantly contributed to increase the world's dollar supply by about $330 billion.
In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by only 1.6 per cent. Nonetheless, the world's supply of dollars increased by a further $460 billion.
Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While one is not sure as to whether the increase in the prices of crude led to the increase of other commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led to the increase in commodity prices as a whole.
Although some of this increase in the world's supply of dollars has been reabsorbed into US economy by the twin American deficits -- current as well as budgetary -- it is estimated that as much as $600 billion remains outside the US.
What has further compounded the problem is the near-zero interest rate regime in Japan. With almost $905 billion forex reserves, it makes sense to borrow in Japan at such low rates and invest elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be approximately $200 billion -- has undoubtedly found its way into the asset markets of other countries.
Most of it has been parked in alternative investments such as commodities, stocks, real estates and other markets across continents, leveraged many times over. Needless to reiterate, the excessive dollar supply too has fuelled the property and commodity boom across markets and continents.
The twin causes -- excessive liquidity due to undervaluation of various currencies (technical) and fear of the US dollar collapse leading to increased purchase of various commodities to hedge against a fall in US dollar (psychological) -- needs to be tackled upfront if inflation has to be confronted globally.
Higher international farm prices impact Indian farm prices
What actually compounds the problem for India is the fact that lower harvest worldwide, specifically in Australia and Brazil, and the overall strength of demand vis-�-vis supply and low stock positions world over, global wheat prices have continued to rise.
Wheat demand is expected to rise, while world production is expected to decline further in the coming months, as a result of which global stocks, already at historically low levels, may fall further by 20 per cent. These global trends have put upward pressure on domestic prices of wheat and are expected to continue to do so during the course of this year.
No wonder, despite the government lowering the import tariffs on wheat to zero, there has been no significant quantity of wheat imports as the international prices of wheat are higher than the domestic prices.
Growth and forex flows
Another cause for the increase in the prices of these commodities has been due to the fact that both India and China have been recording excellent growth in recent years. It has to be noted that China and India have a combined population of 2.5 billion people.
Given this size of population even a modest $100 increase in the per capita income of these two countries would translate into approximately $250 billion in additional demand for commodities. This has put an extraordinary highly demand on various commodities. Surely growth will come at a cost.
The excessive global liquidity as explained above has facilitated buoyant growth of money and credit in 2005-06 and 2006-07. For instance, the net accretion to the foreign exchange reserves aggregates to in excess of $50 billion (about Rs 225,000 crore) in 2006-07. Crucially, this incremental flow of foreign exchange into the country has resulted in increased credit flow by our banks. Naturally this is another fuel for growth and crucially, inflation.
This Reserve Bank of India's strategy of dealing with excessive liquidity through the Market Stabilization Scheme (MSS) has its own limitations. Similarly, the increase in repo rates (ostensibly to make credit overextension costly) and increase in CRR rates (to restrict excessive money supply) are policy interventions with serious limitations in the Indian context with such huge forex inflows.
How about the revaluation of the Indian Rupee?
To conclude, all these are pointers to a need for a different strategy. The current bout of inflation is caused by a multiplicity of factors, mostly global and is structural. Monetary as well as trade policy responses, as has been attempted till date, would be inadequate to deal with the extant issue effectively.
Crucially, a stock market boom, a real estate boom and a benign inflation in the foodgrains market is an economic impossibility.
It has to be noted that the Indian market is structurally suited for leveraging shortages rather effectively. Added to this is the information asymmetry among various class of consumers as well as between consumers, on the one hand, and producers and consumers, on the other.
Further, the sustained flow of foreign money, thanks to the excessive global liquidity in the world, has fuelled the rise of the stock markets and real estate prices in India to unprecedented levels.
This boom has naturally led to corresponding booms in various related markets as much as the increased credit flow has in a way resulted in overall inflation.
Economic policy rests in the triumvirate of fiscal, monetary and trade policies. Theoretical understanding of economics meant that these policies are interdependent.
Also, one needs to understand that growth naturally comes with its attendant costs and consequences. While these policies are usually intertwined and typically compensatory, one has to understand that the issues with respect to inflation cannot be subjected to conventional wisdom in the era of globalisation.
One policy route yet unexamined in the Indian context by the government is the exchange rate policy, especially revaluation of the Rupee as an instrument to control inflation.
It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex issue of managing inflation, while simultaneously address the constraints on the supply side on food grains through increase in domestic production.
A higher Rupee value vis-�-vis the dollar would mean lower purchase price of commodities in Rupee terms. The Indian economy has undergone significant changes in the past decade and a half. With increased linkages to the global economy, it cannot duck the negatives of globalisation.
Sensex ends at low
The Sensex opened with a negative gap of over 100 points at 14,557, which also turned out to be the high for the day. Sustained selling in heavyweights like Reliance saw the index drop to a low of 14,265 - an intra-day swing of over 290 points. The Sensex finally closed with a loss of 338 points (2.31%) at 14,324.
All the sectoral indices closed in the red. The BSE Oil & Gas and Power indices declined 3%. Market breadth was extremely bearish - out of over 2,710 scrips traded, over 1,785 declined.
Reliance declined over 4% to Rs 1,998. Bharti and Reliance Infra also dropped over 4% each to Rs 776 and Rs 992, respectively.
ONGC slipped nearly 4% to Rs 1,035. Tata Power and DLF were also down over 3% each at Rs 1,012 and Rs 485, respectively.
M&M, BHEL, NTPC, Maruti, HDFC, ICICI Bank, L&T and SBI also declined.
Tata Motors gained over 1% at Rs 424. Ranbaxy was up marginally at Rs 459 crore.
Total market turnover (BSE+NSE) was Rs 65,923 crore. Reliance was the most active counter on the BSE with a turnover of Rs 479 crore followed by Reliance Capital (Rs 241 crore) and ICICI Bank (Rs 166 crore).
All the sectoral indices closed in the red. The BSE Oil & Gas and Power indices declined 3%. Market breadth was extremely bearish - out of over 2,710 scrips traded, over 1,785 declined.
Reliance declined over 4% to Rs 1,998. Bharti and Reliance Infra also dropped over 4% each to Rs 776 and Rs 992, respectively.
ONGC slipped nearly 4% to Rs 1,035. Tata Power and DLF were also down over 3% each at Rs 1,012 and Rs 485, respectively.
M&M, BHEL, NTPC, Maruti, HDFC, ICICI Bank, L&T and SBI also declined.
Tata Motors gained over 1% at Rs 424. Ranbaxy was up marginally at Rs 459 crore.
Total market turnover (BSE+NSE) was Rs 65,923 crore. Reliance was the most active counter on the BSE with a turnover of Rs 479 crore followed by Reliance Capital (Rs 241 crore) and ICICI Bank (Rs 166 crore).
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