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India: can inflation be curbed?

, September 2, 2014, 0 Comments

inflation india marketexpress-inIn 2013-14, money supply (M3) increased by 13.3%, real GDP by 4.7% and consumer prices by 9.7%. Money Supply growth is one of the factors contributing to inflation. The RBI, by keeping interest rates high, attempts to control credit expansion and regulate the growth of money supply. A high level of fiscal deficit also contributes to growth in money supply. The RBI maintains that the Finance Ministry should keep its fiscal arithmetic in order before it relaxes monetary policy.

The business community is more concerned about increasing economic growth rates and less so about maintaining price stability. They want the RBI to reduce interest rates which measure can stimulate economic growth. The RBI, on the other hand, maintains that price stability is an essential ingredient needed for sustained economic recovery.

In recent times a major component in the price index contributing to inflation has been food articles. Among food articles the role of items such as fruits, vegetables, milk, eggs, fish, meat etc has been prominent in their contribution to inflationary pressures. In comparison to these the rise in prices of industrial goods has been less prominent. Thus it is items of general consumption by the common man that has played an important role in inflation.

Production of fruits, vegetables and animal products have not been keeping pace with growing demand of the common man for these commodities and the result has been persistent inflation over a prolonged period. While production of food articles has been inelastic, demand for these commodities have been maintained robust by growing per capita incomes of the people, reduction in poverty levels and increase in wage rates arising from government schemes such as NREGA.

A major component of the government’s strategy to fight inflation has been to curb hoarding. In this context it needs to be understood that hoarding can only lead to temporary fluctuation in prices and cannot be the cause of persistent inflation. The type of sustained inflation in food articles as witnessed today cannot be tackled merely by cracking down on hoarders, which can only help in curbing temporary spurt in prices.

The RBI is on the right track when it adheres to a tight monetary policy. Efforts of the RBI need to be supplemented by measures from the side of the government to keep the fiscal deficit under control. Steps taken by the government such as to increase import duty on sugar can lead to increase in domestic price of sugar and contribute to inflation.

Periodic increase in minimum support prices of agricultural commodities has also been an important factor contributing to inflation. The government should restrict increase in MSP to sustainable levels which do not generate inflationary pressures in the economy. The accumulated food stocks with the FCI should also be periodically released in the open market so as to increase domestic supply of food grain in the market and ease inflationary pressures.

The food security legislation that has been enacted can also generate inflationary pressures. It can lead to overall increase in demand for food grains in the country due to supply at reduced prices and a part of this demand will be met by increased procurement from the farmers. The price of supply of grain to the public will be maintained low by providing subsidy. But such subsidies will lead to a ballooning of the fiscal deficit which can be potentially inflationary. Moreover since more food grains will now be consumed by the public the marginal cost of production of grain in the country will go up, which in balance will put pressure on agricultural and food prices.

The purchasing power of the common man for food articles is on the increase due to overall prosperity and rapid increase in economic growth and per capita income. The supply of food articles is in comparison inelastic. Thus there is a persistent growing mismatch in demand and supply of food articles.

This mismatch is more pronounced in the case of superior food articles such as fruits, vegetables and animal products and hence inflationary pressures tend to be more pronounced in the case of these commodities. Since growth in supply of these items is constrained, the supply demand mismatch cannot be wished away and will continue to persist. Thus inflationary pressures in the case of food articles are here to stay. Attempts to eliminate the demand shortage through imports or increased domestic production cannot but lag behind.