The Hindu Business Line : Easy to toss inflation blame on hoarders

Prices of vegetables have shot through the roof in the past dew days. Not even fruits have been spared. Even the wealthy has not been let off from the bite of inflation. May be the effects of the fuel price hike. No, no…surely some hoarders must be storing the goods, or else how can goods suddenly become so expensive overnight?

Disagrees Dr Sunil Rongala, who holds a PhD in international economics from Claremont, California. “People, who are searching for a guinea pig to put the blame on, usually float these sorts of ‘hoarders and middlemen’ conspiracies. For one, hoarders are faceless and it’s usually very easy to put the blame on faceless people,” he tells Business Line.

But India’s inflation index, based on wholesale prices, is not lying. What could be the reasons for inflation to touch 7 per cent, from around 5 per cent even three months ago? What changed? Are we in for a major agrarian crisis? The Hyderabad-based economist answers all that and more in this exclusive interview taken over e-mail.

Excerpts from the interview:

How far is inflation linked with crops?

There has definitely been a supply-side issue in India as far as crops are concerned because of recent reported crop failures. The other big problem in India is that a significant percentage of crop production goes to waste because of lack of proper storage facilities. Yet another supply side issue has been the rise in fuel prices though it should be noted that the rise in fuel prices is well below actual rises in international crude prices.

How much of the inflation is a ‘supply-side’ problem?

It is difficult to say what percentage of the inflation is supply-side and what percentage is demand-side but suffice it to say that it’s a bit of both.

The biggest contributor to the rise of the inflation index in recent weeks has been the rise in prices of minerals, metals, and products such as edible oils. As far as metals are concerned, there has been a worldwide rise in prices in commodities in general and Indian prices have been affected too.The rise in commodity prices is largely believed to be a complex demand and supply issue where one can’t completely pin the reason for price rises. For example, the rise in international oil prices can be blamed on both supply problems as well as a rise in demand.

But surely the problem has a ‘demand’ angle to it…

The demand side is certainly present because people, especially those in the urban areas, have increased their consumption of food articles as their incomes have risen.

What changed in these three months that led to ‘too much money chasing too few goods’?

For one, it should be understood that too much money chasing too few goods doesn’t mean that the central bank is pumping in money. The phrase could be true, even if money supply is constant and there is a sudden ‘negative’ supply shock — where too little of commodities are produced.

That said, there has not been a huge fundamental shift in the past three months. If one looks at the Wholesale Price Index (WPI), the items that have been driving up are minerals, base metals. Iron-ore, which is part of minerals, has been moving up because of the insatiable appetite for steel in countries such as India and China.

Wait a minute. You didn’t mention anything about food articles…

The odd thing is that the index of food articles prices in the WPI has not moved much, though people have been complaining about a huge rise in prices of food articles, and in the markets there has been a rise in the prices of vegetables and fruits. However, what this could be indicating is that the WPI for the week ending April 5, 2008 may become a tad higher on account of higher food prices.

The Government trusts WPI to measure prices. But does it provide a true measure of inflation in our country?

The WPI is not a good or true measure of inflation in our country. It is not even second best. It’s a very poor excuse for an inflation measure. Inflation is after all an index and is a basket of many commodities or services.

The WPI is made up only of 435 goods and commodities. This becomes a problem in a country where over half of the economy is services and not a single service is included in the measure of inflation.

The other problem is that it is prices at a wholesale level while inflation should be measured at the retail level like almost every other country does. Another problem with the WPI is that there is a definite problem with how the weights are set. For example, sugar carries a weight of 3.52 per cent.

Why not use Consumer Price Index (CPI) then?

CPI is obviously a better measure because it considers the basket of goods, commodities, services that an actual person would spend their money on. It would contain items such as house rent etc.

The problem with the CPI in India is that there are four measures of CPI and it comes out with a long lag; a lag that makes it practically useless in the formulation of monetary policy. The only reason why WPI is used is because it comes out much faster.

A school of thought says that hoarders and middlemen are responsible for this spike in inflation…

I don’t really agree with the hoarders and middlemen conspiracy theory. Sure, there must be some people hoarding food but the fact is that to have a significant impact on inflation, one would have to hoard huge supplies of food such as rice etc. To hoard that kind of quantity, you can’t just hide it in a house but you would need large warehouses to store such quantities.

Unless the hoarder is in cahoots with every Government official, it is very difficult to store such quantities of food without getting noticed. People searching for a guinea pig to put the blame on, usually float these sorts of hoarders and middlemen conspiracies. For one, hoarders are faceless and it is usually very easy to put the blame on faceless people.

Commodity exchanges. Don’t they have any effect on the prices?

Commodity exchanges are the other bogeyman to blame rising food prices. Most people don’t understand how futures exchanges operate and this lack of clarity is perfect for people looking for scapegoats.

The truth is that unless there is rampant manipulation of the system, the prices of commodity futures generally reflect the demand and supply for a commodity. There are enough safeguards in most exchanges to see if there is an intentional manipulation.

Of course, for a system to work well, it should have liquidity. Commodity futures exchanges were blamed the last time around for food price rises and as a result the trading of some commodities was banned. The reality is that commodity futures provide a valuable indicator to farmers to see which direction the wind is blowing and it helps them in making decisions on what crops to plant.

The biggest problem in my view in finding scapegoats is that it takes focus away from addressing the real problems. I think it is ‘scapegoatism’ because there was a recent news story that showed that one lakh tonnes of wheat got spoilt in a railway station in Maharashtra, because there was no protection from the rain. In my view the people who let that happen are more responsible, than hoarders or their ilk.

What would be the plausible measures taken by Government to contain the rising prices?

In most advanced countries, the only institution that would usually tackle inflation is the central bank. In India, it is a tag team effort, which in my view is not necessarily the best thing. The adage of too many cooks spoil the broth fits fairly well here.

The RBI has two policy options, one is the interest rate and the other is the cash reserve ratio.

Increasing the interest rate may be too hot politically and also because since a good part of the inflation is supply driven, interest rates may not necessarily work. The other problem is that monetary policy actions have a long time lag to take effect and given the economy is slowing; it may hit the economy at the wrong time.

However, as inflation rises, interest rates must rise because real interest rates have to always be positive otherwise it may lead to excess money demand that in turn will lead to higher inflation.

The other policy is to increase the cash reserve ratio and the RBI may well turn to that because it’s fast, easy and more politically comfortable. All said, the RBI is caught between a rock and a hard place.

The RBI might be in a spot, but the Government may be better placed to handle situations as these. Isn’t it?

As far as the Government is concerned, by Government I mean the Finance ministry and other ministries, they should not be involved in the inflation-fighting effort.

A plethora of academic literature points to Governments always having only a short-term perspective; and fixing prices or banning exports are examples of having a short-term perspective. Sure, they do reduce prices in the short run but it could be ruinous in the longer-term.

Basic economics teaches us that as prices reduce, producers have less of an incentive to produce that particular good. Therefore, in the longer-term, when the supply of those goods reduces and prices rise, the Government will be left with zero options.

Given the public pressure, what do you suggest the Government should do?

What the Government should do, instead, is think longer-term, and one good way they can do is to increase the rural infrastructure in terms of cold storage facilities etc.

A significant amount of crop produce in India rots for want of refrigeration and storage facilities and to build these facilities in order to increase the supply of food-grains is not exactly rocket science.

The other thing that the Government needs to do is to help in increasing the yield of crops. A recent report has indicated the crop yield in India is half of that of China. One of the biggest culprits is an imbalance of soil nutrition and many experts have said that India needs to amend the fertiliser subsidy policy to also favour complex fertilisers and not just urea. This has to be done in order to get a better soil nutrition balance and therefore, a better yield.

What could be the effects of inflation on the Indian rupee?

The inflation rate that India currently has is not a life-threatening inflation. Countries have experienced inflation that has ripped their lifeblood out. Zimbabwe is one case in point where inflation levels are said to be over 100,000 (yes five zeros!) per cent and which has decimated that country.

High levels of inflation first debase the currency of the country. It can get to a situation where one has to carry huge bundles of money to just buy a loaf of bread and what is happening in Zimbabwe is what happened in Germany in the 1920s.

If a currency is debased or if it becomes worthless, its foreign exchange value is going to come down dramatically. The value of a currency depends on demand and supply (at least in most cases) and if a currency loses its value, no one is going to want to exchange money into that currency.

Typically in countries that have hyperinflation, the authorities usually fix exchange rates and they are usually meaningless. What one needs to see is the black-market premium being offered for hard currencies and that usually reflects how low the currency has sunk.

The perfect example again is Zimbabwe. In March, the official exchange rate was US$1- 30000 Zimbabwe dollars while the parallel or black market rate was US$1-24,000,000 Zimbabwe dollars (24 million) on March 1 and this deteriorated to US $1- 70,000,000 Zimbabwe dollars (70 million) on March 19.

Inflation’s effect on stock market…

On equities, it has an indirect effect because after all equity prices do factor in the future prospects of the economy. High inflation rates usually mean that the economy will slow down in the future and that means reduced earnings for companies and this obviously means lower stock prices.

A sector that usually gets affected more is the banking sector, which usually faces the brunt of interest rate rises that usually follow increased levels of inflation.

Do bonds too get affected in an inflationary environment?

Bonds will also get affected with the yields on long-term bonds increasing. In a bond market, the prices of bonds and yields are inversely related. This means that if yields are increasing, prices of bonds should be decreasing. The reason why the prices of long-term yields start to fall is because people start to buy less of that country’s bonds since they have lost faith in that country and because inflation erodes the value of the return from bonds in real terms. However, in India it has been reported that bond yields are set to rise because the RBI is going to sell more bonds to suck liquidity of the country. In this case, it looks to be an over-supply of bonds.

Bio

Mr Rongala is the co-author of ‘Asia in the Global Economy: Finance, Trade and Investment’ (along with Prof Ramkishen S. Rajan of George Mason University, US), released in January 2008 ( www.worldscibooks.com/economics/6392.html). Mr Rongala is currently a research manager in an international partnership firm in Hyderabad.

D. MURALI

KUMAR SHANKAR ROY

http://InterviewInsights.blogspot.com

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