The Hindu Business Line : When inflation is good and bad news

Inflation will, undoubtedly, put pressure on both individuals and organisations alike in the short run. But, eventually, price rise will help strengthen developing countries vis-à-vis industrialised countries.

The four causes of the present price rise are the increase in the prices of food items, the raising of interest rates by the Reserve Bank of India, the high rate of economic growth, and the increase in crude oil prices. The first three are good news while the last one is partly so.

The price of agricultural goods vis-à-vis industrial products has been falling in the last two decades. The Maruti 800 sold for Rs 55,000 in 1984 when the price of wheat was Rs 5 a kg. Now, the price of the Maruti is around Rs 2,20,000, while the price of wheat only recently inched up to Rs 10 a kg. It should be about Rs 20, if parity is to be maintained.

Balancing act

The present rise in the prices of food items, therefore, is not only good news for the farmers but also rectifies the imbalance that has been developing in terms of trade between agriculture and industry. The RBI raising interest rates is indicative of the stiff competition India is posing to the Western economies.

The root of the problem is that foreign companies are unable to sell their goods in the developing countries. The US is importing goods worth $600 billion more than it is exporting because its businesses have become uncompetitive. Indian companies have acquired frontline technologies and the US is losing its edge.

It has become difficult for the US to attract global capital on the New York Stock Exchange. This has forced the US Federal Reserve Board to increase interest rates so that world capital continues to flow into the US economy.

A weak company routinely offers higher interest rates on fixed deposits and bonds. Similarly, a weak US economy is offering higher interest rates on Treasury Bonds. The increase in interest rates by the RBI is only a reaction to counterbalance this move of the US Fed so that world capital does not flee our markets wholesale. The interest rate hike, though leading to inflation, also indicates that the Indian economy is on the ascendant; and that the US is on a decline.

This increase in interest rates will put pressure on Indian businesses but companies will emerge unscathed because their Western competitors are facing a higher-interest-rate regime.

High growth rate

The third source of price rise is the economy's high rate of growth. The rate of growth stood at annualised 9.3 per cent in the first quarter of this year.

The non-food credit extended by banks to trade and industry increased last year by 37 per cent against 27 per cent the previous year.

Faster economic growth means there will be more demand for steel, cement, labour and transport in the economy. This is leading to an increase in prices. This is a natural process by which the market transmits signals. In the next few years, supply will increase and prices will fall to their normal levels.

The problem here is that people do not remember that their incomes have increased while paying Rs 10 against Rs 8 for a kg of wheat. The average salaries of government servants in 1995 were 3.6 times the per capita income of the people. They increased to 4.8 times in 2000. Now, the Government is to establish a Sixth Pay Commission to further raise the salaries. Yet, government servants fretabout the Rs 2 increase in the price of wheat. This price increase is good news because it signals the ascendance of the Indian economy on the world platform.

Soaring crude oil

The fourth source of price rise is the high price of imported oil. Prima facie, this is harmful for India. But it is also a presages a realignment of world consumption. Twenty per cent of the people living in industrial countries are consuming 80 per cent of the world's resources. The increase in oil price changes this.

Industrial nations as a group are net importers of oil while developing countries as a group are net exporters. Thus, increase in the oil price strengthens the position of the developing countries vis-à-vis the industrial nations. Surely, oil-importing developing countries will suffer in the process but this must be borne. After the oil shock of the 1970s, the average rate of growth of industrial countries declined from about four per cent to two per cent but that of the developing countries increased from about three per cent to five per cent.

The coming years will see a further slowdown in the industrial countries. India, particularly, has less to lose from this. The $22-billion-a-year remittance by expatriates from West Asia is likely to increase and partly compensate the outflow due to higher price of crude oil.

The present increase in prices, however, will affect the poor. Their incomes are not likely to increase, though they will have to pay more for their purchases. The solution to this has to be found in implementing policies that generate demand for labour and higher wages. It would be retrogressive to seek solutions to this problem merely by decrying the present increase in prices.

(The author, an economist, is a freelance writer. E-mail: bharatj@sancharnet.in)