Monday, July 12, 2010

Is Inflation problem India-Specific?????????

The year-end inflation figures as given from CIA Fact Book for India are 8.3% (2008) & 10.9% (2009), respectively. This year we have seen double digit inflation figures with WPI being at around 11 % in March 2010. Strong demand, supply constraints, rise in oil prices all are set to pressurize the Indian Government while making economic policies.

As recently we saw central bank’s initiative to tame inflation by shifting the BPLR system to the base rate system in which credit could not be lent to anyone at a rate below the base rate. Sure enough, this way of contracting the money supply help in taming inflation as the interest rate would be transmitted to the end-consumer in this way & hence would curb their spending thereby reducing their demand, & hence control the supply led inflation.

But the issue of concern is that is this inflation problem India-specific or is the same with other developing economies as well.

"This time around, inflation does appear to be an India-specific phenomenon, as there are no global factors at play as was the case during 2008," said Mr. Saumitra Chaudhuri, Member of the Planning Commission.

The question to ponder over is that is the RBI’s measure only sufficient to control inflation or we need to do something over our aggregate supply. Well, in the short-run, it would be impossible to increase our aggregate supply because it will take some time to start new plants and all. In the short-run, contracting money supply is the measure while in long run, focus should be towards improving the supply side.

When we see in developing economies like BRICs nations, we see that unlike India & China, Russia’s inflation has declined considerably. The reason may be attributed perhaps to the fact that India & China are already working at nearly full capacities & hence growing demand in these economies is further causing the inflationary pressures to rise.

What is your opinion from India’s perspective????? Is inflation problem India-specific????Are we running at nearly full capacities????Is RBI’s step sufficient to tame inflation?????


Anjana Khanduri said...

I think the BPLR change done by RBI is not to curb inflation. The BPLR rates could only add to the transparency in the banking system and make things more clear.

As far as inflation is concern, we know that is because of inadequate supply of primary articles and despite the inflation figures being reflected very low I my observed prices of some essential vegetables going up by almost 250% in summers and as supply and demand of these commodities balanced the prices came down.
So the only method I see to reduce inflation in food prices inflation is pay little bit attention to neglected sector of India “Agriculture”.

Esha said...

BPLR alone can't curb inflation but it's surely aimed at improving the transmission mechanism of the monetary policy due to which the base rate would not be violated by banks.
Regarding controlling inflation, in the short run only interest rate is the measure. For sustainability in economy, we need to be strong in supply side but it would take longer time as a new plant would take at least 2-3 years to function. In the short-run, we can't do too much on supply side.

neha said...

Throwing light on the problem of inflation being India specific I would like to quote some figures in which India was seen to have the largest general inflation ( at 10.16%) and the food inflation (16.49%) in the month of may, which is way above the other developing counterparts (Business line, July 9,2010).

Inflation is today a structural problem which will take time to settle down and one cannot ignore the need of fixing up the supply side constraints in the food- whether it be production or distribution for that matter. However such steps cant be implemented in a short span.

In order to reduce inflation the RBI has already taken a step of rising the repo rates and the reverse repo rates much before the policy review that will come by the end of this month. The RBI is expected to further increase the rates. Such steps taken by RBI are like baby steps being implemented step wise and the role of expectations here can also be thought of in a way that industries expecting a rise in the rates may borrow now to prevent a rise in the cost in the future.

Coming to the base rate system, the new system is mainly to increase the transparency and prevent the below prime lending rate lending to the corporates. however the base rate system will also have some other impacts such as increasing the speed and ease with which the transmission mechanism works and so that the steps taken at the top reaches the grassroots level. And hence any increase or decrease in policy rates can reach the common man to have a faster impact on the macroeconomic problems such as inflation.

Addy said...

The main rationale of RBI in introducing "Base Rate" regime is to bring transparency in lending activities of the bank. In addition to this RBI is expecting with this decision that credit flow to small and medium sections will increase, whereas lending at low rates to corporate houses will decrease. Therefore this does not indicate any major step towards reducing the liquidity in the system and hence it can be said that the role of "Base Rates" as a measure of inflation control is minimal.

In my opinion the inflation problem is India-specific:

Let us consider the root cause - "FOOD INFLATION", which is relatively difficult to manage and which has spread to broader industrial categories especially “Manufacturing”. One of the reasons for this food price inflation is increased wages. Programs such as NREGA etc. on one hand have raised the rural wages, but on the hand have kept their prime focus on employment and not on productivity. This wage rise has exceeded the agricultural productivity and in turn raised the food prices. And we know that a relative price change raises the general price level. Moreover, food and fuel consumption are inelastic, since they are the necessities of existence. Normally the objective of monetary actions is to reduce aggregate demand. As a result a rise in interest rate will slash the demand for and spending on discretionary goods, but will have no impact on the prices of essentials. Therefore RBI should not be containing inflation through demand contraction because it is a result of supply side deficiency.

In my opinion taming of current inflation requires “simultaneous” and “aggressive“ Fiscal & Monetary measures and it is due to the lack of these measures the steps taken, so far, by RBI and Indian government are insufficient. In fact, it is now recognized that it may be better to sacrifice a bit of growth to reduce inflation. The need of the hour is that government can reduce import duty (as they did in late 2009) on the essential commodities, doing which will reduce the essential commodity prices. At the same time, although it prefers to adopt a gradualist approach, RBI can increase the repo rate from 5.5% to 6.5% and increase cash reserve ratio from 6% to 6.5%. By doing this the spending and investment activities will be curbed and thereby to a larger extent inflation can be controlled.

I would also like to give my view as to what are the challenges RBI can face if it resort to monetary measures by raising interest rates. Rising interest rates no doubt will help containing the inflation, but it will also attract more capital inflows, “HOT MONEY”. Capital inflows result in build-up of foreign exchange reserves. As these reserves are used to buy domestic currency, the domestic monetary base expands without corresponding increase in production: too much money begins to chase too few goods and services. In such case RBI can resort to “STERLIZIATION” with the help of which domestic component of monetary base is reduced to offset to reserve inflow.

Pri said...

Current state of the Indian Inflation is just a testimony to the fact that the monetary measures by RBI are just very short lived to contain it. Since 2009 till date, Inflation has kept coming back to a double digit number. Its' high time that the government should realize that it's not demand side but supply side economics that can actually sustain the inflation curbing measures for a longer time.
With a growing country like India, containing inflation through monetary measures is self destructive. Need of the hour is to improve efficiencies of the production side within the country in order to match the demand. Over utilizing the plant capacities does not mean that what they are producing is the most efficient output. Rather than making environment harmonious for the service sector, GoI should soon start investing heavily in the manufacturing technologies. With an increased output not only the inflation would come down but it would give an edge to the Indian industry to offer better products to the rest of the world at competitive prices.

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