Persisting high inflation points to the failure of the Government to properly recognise and attempt to address structural tendencies and adopt appropriate short-term measures.

Inflation, as measured by the Wholesale Price Index for all commodities, stood at above 8 per cent over the last twelve months and above 10 per cent in four of those (Chart 1). This is disconcerting not just because of its level, but because of its persistence.

Inflation persists because its incidence has shifted across commodities, though more often than not it has been focused on one set of food articles or another. That makes it more damaging when looked at in terms of its welfare consequences for the people and its political consequences for the UPA Government.

These features make it unclear as to why the Government has not, on a war footing, made an effort to dampen price increases — especially since it has the advantage of large foreign exchange reserves that can be deployed to augment supplies of any tradable commodity when required. This is a moot question also because the Government has on more than one occasion argued that inflation is not a generalised problem but has attributed it to supply-demand imbalances in particular commodities, which then provides the base for speculation.

Across commodities

If it has not been able to exercise the manoeuvrability it derives from comfortable foreign exchange reserves to dampen inflationary trends through supply management, it is partly because of an unusual feature of the inflationary process. This is the fact that it has moved across a range of primary commodities, especially food articles.

Inflation has affected one or more of cereals, pulses, onions, vegetables, meat, eggs, milk and a host of other commodities at different points in time. With the incidence of such inflation being high in many instances, even if the overall weight of individual commodities varied, the effect has been such as to keep overall inflation at relatively high levels.

One consequence of this moving inflationary frontier is that a patently lackadaisical Government has been caught off guard on more than one occasion. In fact, driven by its belief that specific demand-supply imbalances were responsible for the problem, the Government seems to have consistently expected inflation to moderate quickly rather than rise significantly.

Almost a year ago, when addressing a Chief Minister's conference on food prices early in February 2010, the Prime Minister, Dr Manmohan Singh, declared: “The worst is over as far as food inflation is concerned. I am confident that we will soon be able to stabilise food prices.”

Three months later, on more than one occasion, government spokespersons, like Chief Economic Advisor Dr Kaushik Basu, declared that inflation had “peaked out” and was on a downward trend. One or two predictions of an impending price decline are understandable. But, over the last year, almost every month or even week, one official spokesperson or the other (be it the Finance Minister, the Finance Secretary, the Deputy Chairman of the Planning Commission or the ubiquitous head of the PM's Economic Advisory Council) has declared that inflation is bound to moderate.

One reason for this is that the Government did not realise that the demand-supply imbalance that it was dealing with was more generalised than it thought it was because of the agrarian crisis resulting from a long-term neglect of agriculture.

That neglect has obviously meant that investments and expenditures that could have boosted agricultural productivity have been woefully inadequate. This has combined with increases in input costs resulting from the perceptions on appropriate pricing of inputs and the need to reduce subsidies that has characterised the reform period.

As a result, even in instances where the Government has contributed to pushing up output prices, the viability of crop production has not been sustained despite the high-input and high-output price regime. The implication for the trend (as opposed to weather-influenced fluctuations) in agricultural growth can only be adverse

As leading economists have noted, what needs explanation is not the fact that we are faced with inflationary tendencies rooted in structural demand-supply imbalances today, but the fact that this problem has not erupted before.

This is partly because deflationary policies reined in demand as well for some time. Matters have changed since, necessitating short term supply management measures to combat inflation. Unfortunately, the Government has failed on this front as well.

Role of speculation

The impact of that failure has been exceptional also because of the role that speculation has come to play in the deregulated and liberalised environment put in place during the last few years. At an aggregate level there are a number of features of the inflationary process that point to this enhanced role for speculation.

The first is that, while inflation is not restricted to food alone, it has been substantially driven by food articles, which are more prone to speculative influences. In the case of these commodities, even when demand-supply imbalances are minor or absent, speculation can push up prices.

The second is that within food articles, inflation has at different points in time affected different commodities, such as cereals, pulses, vegetables, eggs, meat and milk. Not all of these commodities are equally weather dependent and the prices of some are influenced by where administered prices are set.

To attribute the trends in their prices solely to demand-supply imbalances or imported inflation is to neglect the role of speculation. Third, when inflation does occur in some food items, be they onions, vegetables or even cereals, the rate of inflation tends to be extremely high, pointing to the role of speculation in driving prices in the short run.

A role for speculation is also established by recent evidence on distribution margins. There is reason to believe that the margins between wholesale and retail prices of many important food items have increased in the recent period. (See Macroscan, Business Line, February 23, 2010.)

The point is that this has been happening in a period of increased corporate involvement in food distribution and food retail. The share of corporate retail in food distribution in the country as a whole is estimated to have tripled in the past four years, and has grown even faster in major metros and other large cities. And this is also the period when retail food prices have shown the greatest increase.

The other point that emerges from a comparison of retail margins across major towns and cities is that such margins are lowest in States (such as Tamil Nadu and Kerala) where there is an extensive, well-developed and reasonably efficient system of public distribution that provides a range of food items on a near universal basis to the population. In regions where such a public distribution system is weak or non-existent (such as Utter Pradesh and Bihar) the margins tend to be much higher and growing faster.

In this context, consider how retail margins have been behaving in the very recent past, in just one location, the city of Delhi. Charts 2 and 3 describe the price behaviour of two significant but relatively less perishable food items: rice and tur dal.

It is evident that the retail prices have generally been tracking the wholesale prices in terms of direction of movement, but still there are some noteworthy variations. On average, retail margins have increased for these commodities, and quite sharply for tur dal. This may be the result of a number of features, and obviously requires more investigation. But even so it is worth noting that Delhi is a city that has witnessed a significant increase in corporate food retailing. And the role of inflationary expectations in being able to influence retail price behaviour is obviously much greater for larger players.

The case of onions

The food prices that have been most talked about of course are those of onions. Onion prices are widely perceived to have great political significance, especially in North India. Because onions like other vegetables are highly perishable, supply conditions should play a major role in their price. Charts 4 record the wholesale and retail prices, and the total market arrivals (in metric tonnes) of onions in the city of Delhi.

The evidence is somewhat surprising. For much of the period of falling market arrivals over the past year, onion prices were rather stable and the retail margin actually shrank. Prices started rising sharply only in October — and this is the period after which supply was actually increasing quite sharply.

In November and December, market arrivals increased but prices continued to shoot up. Surely inflationary expectations and hoarding must have played roles, along with the speculative pressure reflected in onion futures, and this was not sufficiently counteracted by public intervention through its own food distribution network.

The Government has recognised this structural, inflationary tendency in a peculiar, in fact patently absurd, way. It attributes the inflation to the demand-side effects of high growth. If people are richer because of an 8-9 per cent growth rate, they are bound to demand more. Since supply does not adjust, prices are bound to rise.

There are many assumptions here. That when GDP grows, those who need to buy and consume more cereals, pulses and vegetables garner a reasonable share of the benefits of that growth. Or that when GDP grows, such growth cannot occur in large measure in the commodity producing sectors, resulting in a widening gap between the demand for and supply of certain goods. That even though the “high growth” era began in 2004, it is only now that it has generated demand-supply imbalances. And, that if there is indeed a supply-demand imbalance the government is unable, for whatever reason, to redress it by resorting to imports. Making such assumptions is not just wishful thinking, but avoiding the conundrum.

A priority issue

Dealing systematically with the problem of high food prices in a country with a largely hungry population should normally be a priority issue for any government. There are certainly crucial medium-term policies that reverse the longer run neglect of agriculture, which must be implemented. The issue of rapidly rising cultivation costs that are making farming unviable once again needs to be addressed in a holistic way.

The concerns of storage, distribution and post-harvest technology also need to dealt with. But in the short run, creating a viable and effective public distribution system that will counteract tendencies to price spikes in essential commodities is an immediate requirement.

Unfortunately, precisely at a time when it can come in handy the Government is threatening to renege on the UPA's promise to deliver universal access to a minimum quota of food through the public distribution. Riding on the argument that not enough foodgrain is available, even though production has been good, stocks with the government are comfortable and foreign exchange that can be used to import even more is being handed over to the rich to be transferred to accounts abroad, it has used the Chief of the Prime Minister's Economic Advisory Council to stall even a diluted proposal from the Sonia Gandhi-led National Advisory Council to expand the public distribution system. If this attitude persists, possibly high inflation too will.

(This article was published on January 25, 2011)
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