The hidden worm in inflation

In February, the newly constructed all-India consumer price index (CPI) truly came into effect. For the first time, we had index numbers (for January 2012) that could be compared with those for January 2011, when the first set of the composite CPI index numbers were put out. The index numbers would take us closer to the practices of developed economies of using retail prices to calculate inflation.

Welcome change

In March, the Ministry released February's price data, noting an increase in the rate of the “All India combined CPI” of roughly a percentage point to 8.83 over January.

The price rise was higher for urban than rural areas by 1 per cent. But the rate for food in both rural and urban were just around 2 per cent; the bulk of the price increases seemed to have centred around milk and milk products, eggs, oils and fats, all of which were 10 per cent or more.

Most policymakers have in the past commented on such a price trend as reflective of changing food habits, implying a shift towards prosperity in general; since the price rise in “essential” items such as cereals and pulses stays low at an average of 3 per cent, it would appear that food habits mirror more ‘sophisticated' tastes.

What the CPI trend seems to suggest is not just the fact of high inflation in both rural and urban areas, but one fuelled by a redefinition of “essential” consumption.

Mis-measuring price rise

It could also mean something more banal and frightening, that demand for food such as cereals and pulses has declined because an increasing number of people at the bottom do not have the means to buy them, even as more people at the middle or higher income groups switch to foods indicative of “prosperity”. What we would then have is a widening chasm between populations than ever was the case.

But a more pertinent question might be the following: How are prices rising for such items as milk and eggs, considering India has the reputation for being one of the top producers of dairy products, vegetables and fruit? Surely, demand could not outpace supply to such an extent that prices shoot up into double digits?

One answer, among others, probably lies in the fact that as much as 20-40 per cent of such produce rots away. Fragmented supply chains, wastage on account of perishability skims off almost a third of the products from the consumer. So despite high output, prices still rule high: “supply chain inefficiencies” ensure an upward bias in prices and keep such “essential” protein-rich foods out of reach for the very poor. The high cost of such items clearly has a deleterious effect on incomes.

From the viewpoint of inflation, these inefficiencies connote the extent to which the relative advantages of abundant supply can be neutralised. Inflation is no longer just the function of output in the demand-supply equation; it is also the result of the quality of supply chains (improvements or deterioration) that add their own substantial weight to pushing up prices.

This might appear fairly obvious. But in the measurement of inflation such a qualitative yardstick — rot and wastage — does not figure. If they did, the rate of inflation would probably have to be adjusted upwards as much as any drop in supply that alters the demand-supply equilibrium.

This means that when policymakers bemoan the lack of a good monsoon and blame it for inflationary pressures, they tell us half the story. More than a bad or fickle monsoon it is shoddy supply management that adds to the pressures. Since inefficiencies of such a sort are not monetised they do not figure in the calculation of the official price index. What we get in the bargain is an underestimation of inflation, and thereby an overestimation of real incomes with which consumers could drive growth forward.

When the Supreme Court rapped the union government for the way huge quantities of food grains were rotting even as people were dying of hunger, it brought to public notice what had been known for long. But as yet we do not know what the impact of that wastage has been on prices; quantifying that lack of quality improvement in storage would give us a higher and more genuine measure of inflation and its pernicious effects on incomes and consumption.

Biases in inflation

There is a vast gap between the way people perceive inflation and its official calculation. Underestimating the impact of poor delivery mechanisms, the abysmal lack of improvements in the way output is routed into the consumption channels, tends to distort the picture of disposable incomes by a “mis-measurement” of inflation.

Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi cite America's Boskin Commission in the mid-1990s that suggested the inflation rate be reduced 1 per cent because policymakers had underestimated quality improvements in the economy (the use of Internet for example, sales in discount stores), or in short, changes wrought in supply chains — delivery systems that the Commission felt had been ignored in the calculation of inflation.

In India's organised economy such changes could conceivably have a positive impact, considering the efforts by companies to improve supply chains, to use the Internet instead of snail mail, thus shortening delivery periods and storage/inventory costs.

Such improvements would impact manufacturing inflation and purchasing power in that sliver of the national economy; but to the extent that inefficiencies and wastage abound in the rural and farm sector from which inflation sets off to wreck real incomes and real progress, could not one say that our vaunted prosperity is partly illusory?

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