Food inflation continues its upward march in August - Atasi Das

India, currently Asia's third-largest economy, has been one of the prime drivers of the Asia led global economic recovery, recording around 9 percent growth rate in the last quarter. High growth figures have however failed to diffuse the inflationary trend faced by India particularly in food inflation, since 2009. [Inflation is a situation of rising prices accompanied by a consequent decline in purchasing power]. India’s sustained food inflation has been attributed to a combination of structural and cyclical factors. Analysts fear that a sustained buildup of food inflation for a prolonged time period, may actually lead to the building up of inflationary expectations, which will further fuel the spiraling rise in prices. [Expectations shape the actions of economic agents].

The August 2010 picture…
India’s food inflation clambered up to 11.47 per cent for the week ended on 28 August 2010, backed by soaring prices of cereals, fruits and milk and supply lags due to sporadic floods in some parts of the country. In the concerned week, the prices of pulses, rice and wheat increased by 13.44 per cent, 4.74 per cent and 7.04 per cent respectively on a yearly basis; milk and fruit prices rose by 17.60 per cent and 10.34 per cent respectively, as compared to the same period in 2009. Vegetable prices registered an overall decline of 9.38 per cent on an annual basis (with marked decline in potato and onion prices). On a yearly basis, prices of cereals increased by 5.07 per cent in the week ended on 28 August 2010, compared to that in 2009.  Food inflation figures displayed an upward trend for the second consecutive week in a run, after a brief softening of prices during July to the first half of August 2010. Food inflation was 10.86 per cent in the week ended on 21 August 2010. India’s headline inflation stood at 9.97 per cent in July 2010. India’s food inflation is expected to tame down to a modest 6 percent by March 2011 on the back of a countrywide good monsoon and the ‘base effect’. Food price index is awarded over 15 percent ‘weightage’ in the broader wholesale price index used for measuring inflation. The Reserve Bank of India (RBI) has raised the repo rate by 100 basis points to 5.75 percent and the reverse repo by 125 basis points to 4.50 percent since March 2010 in response to the inflationary trend. India’s headline inflation has remained the highest amongst the leading G20 countries. The RBI is expected to further raise its key rates in its 16 September 2010 policy review for containment of inflationary pressures in the economy.

The economic fundamentals
When RBI raises its lending rates, the cost of credit rises in the banking system and the commercial banks raise their lending rates in response; loans become dearer. Interest rate rises and private investment falls. As money is sucked out of the system consumption demand also falls. An overall fall in aggregate demand leads to a decline in output and employment and economic growth suffers. But with the mopping up of the excess money supply in the economy inflationary tendencies are checked in- as inflation is simply a situation of “too much money chasing too few goods”. This policy works well for a typical ‘demand pull inflation’ situation. India’s current food inflation is of a cost-push nature primarily arising out of its supply-side bottlenecks, which need structural adjustments. A long run solution to this problem may be reached through the augmentation of the productivity and competitiveness of the agricultural products, creation of better infrastructural facilities for transportation and storage of food items and ensuring the food security of the masses through targeted subsidies doled out through the state sponsored distribution systems.

Since the Asia led global economic recovery has been projected to be sluggish, jobless and credit constrained in its initial years, the ogre of inflation will make policy coordination difficult for the monetary authorities, who need to sustain the domestic growth momentum alongside containing the inflationary pressures. Rising prices also have political repercussions and are likely to erode the voter base for the ruling UPA coalition in India.

Critique
Jong-Wha Lee, Chief Economist of the Asian Development Bank (ADB) had said on 19 August 2010 that ADB may consider a revision of India's projected growth and inflation figures for the current fiscal (which now stand at 8.2 per cent and 5 per cent respectively), in view of the soaring inflation rate of the country in the first half of the fiscal year.
Lee observed that India’s inflation was primarily being driven by the sustained supply side food inflation; double-digit food inflation figures have affected our lower middle class, who needs to spend a high proportion of their income on food and beverages. Lee acknowledged RBI’s “tight monetary policy” stance as a step in the right direction for squeezing in the inflation, but warned that excessive rate hikes could also bring in heightened capital inflow and its associated problems. Lee opined that the Indian economy could attain ‘sustainable economic growth’ with a low inflation rate, if it manages to rope in: a sustained economic growth momentum with a hike in agricultural productivity, requisite infrastructure growth and fiscal consolidation.

Conclusion
The International Monetary Fund had expressed concern in June 2010 that, rising oil and food prices have build up inflationary, budgetary and balance of payments pressures for nations globally; in countries with below par poverty reduction levels the negative impacts of soaring food prices have been disastrous. Fortunately, Montek Singh Ahluwalia, India’s deputy chairman of the Planning Commission holds that the inflationary pressures in our economy will subside substantially by December 2010.

Footnote: Key RBI policy instruments for controlling liquidity
CRR: A statutory fund a commercial bank needs to hold with the RBI.
Reverse Repo: The rate at which RBI borrows money from the commercial banks.
Repo: The rate at which RBI lends money to the commercial banks