Who Does Low Inflation “Really” Benefit?


Every month the ministry of statistics and programme implementation declares the inflation based on the consumer price index. Inflation is essentially the rate of price rise. The inflation for the month of June 2017, came in at 1.5 per cent.

This basically meant that prices in June 2017 overall were higher by 1.5 per cent in comparison to June 2016. This is the lowest inflation that the country has seen over the period of last five years.

Hence, not surprisingly, the government moved very quickly to claim credit. Arvind Subramanian, the chief economic adviser to the ministry of finance, said: “This low, heartening number is consistent with our analysis for some time now.”

This is one of those statements that makes economics the subject that it is, where equally convincing arguments can be made from the two ends of the spectrum.

Allow me to explain.

Low inflation is heartening because the rate of price rise has come down. It needs to be understood here that low inflation does not mean lower prices. It just means that the rate of price rise has come down than in comparison to the past and that is a good thing. Or so the chief economic adviser would like us to believe.

The question is why has the rate of inflation come down? The consumer price index that is used to calculate inflation is made up of a large number of goods and services. The government tracks the prices of these goods and services across the country, in order to arrive at the inflation number.

Food and beverages constitute around 45.9 per cent of the index. Food and beverage prices fell by 1.2 per cent in June 2017 in comparison to June 2016. In fact, prices of some of the constituents like pulses and vegetables have fallen at a much faster rate than the overall rate.

The price of vegetables fell by 16.5 per cent and that of pulses fell by 21.9 per cent. Vegetables and pulses together constitute a little over 8.4 per cent of the index.

So, what does this mean? It means that the overall rate of inflation is down because food prices have actually come down. Lower food prices essentially mean that the farmers growing food, have sold what they grew at a price lower than they had in the past. Also, these lower prices do not always reach the end consumers, with middlemen taking in a bulk of the benefit.

There have been many stories in the media portraying the plight of these farmers who have had to sell their produce at lower than their cost price and face losses and get even more indebted. In fact, it is not surprising that over the last few months, there has been so much demand for loans to farmers to be waived off, all across the country.

The larger point is that if inflation has become very low then someone is not being paid as much as he was in the past. And this can be due to various reasons. In this case that someone happen to be farmers. Farmers form around half the working population. If they face losses then they are less likely to spend as much money as they had in the past. This will impact rural growth and in the process, the overall economic growth.

Hence, when Subramanian finds low inflation heartening, he ignores this line of thought totally. As Evan Davis writes in Post Truth—Why We Have Reached Peak Bullshit and What We Can Do About It: “There are certainly such things as facts, and no one should persuade you otherwise. But aside from quite banal facts (‘the sun is shining’) we always have to use judgement in deciding what is a fact and what to believe: we have to apply a judgement as to the weight of evidence in its support relative to the weight of interpretation put on it.”

The column originally appeared in the Bangalore Mirror on July 19, 2017.


If only Raghuram Rajan could control onion prices too


On November 12, the rupee touched 63.70 to a dollar. On November 13, Raghuram Rajan, the governor of the Reserve Bank of India (RBI) decided to address a press conference. “There has been some turmoil in currency markets in the last few days, but I have no doubt that volatility may come down,” Rajan told newspersons.
Rajan was essentially trying to talk up the market and was successful at it. As I write this, the rupee is quoting at at 63.2 to a dollar. The stock market also reacted positively with the BSE Sensex going up to 20,568.99 points during the course of trading today (i.e. November 14, 2013), up by 374.6 points from yesterday’s close.
But the party did not last long. The wholesale price inflation (WPI) for October 2013 came in at 7%, the highest in this financial year. In September 2013 it was at 6.46%. In August 2013, the WPI was at 6.1%, but has been revised to 7%. The September inflation number is also expected to be revised to a higher number. The stock market promptly fell from the day’s high.
A major reason for the high WPI number is the massive rise in food prices.
Overall food prices rose by 18.19% in October 2013, in comparison to the same period last year. Vegetable prices rose by 78.38%, whereas onion prices rose by 278.21%.
Controlling inflation is high on Rajan’s agenda. “Food inflation is still worryingly high,” he had told the press yesterday. In late October,
while announcing the second quarter review of the monetary policy Rajan had said “With the more recent upturn of inflation and with inflation expectations remaining elevated… it is important to break the spiral of rising price pressures.”
If Rajan has to control inflation, food inflation needs to be reined in. The trouble is that there is very little that the RBI can do in order to control food inflation.
A lot of vegetable growing is concentrated in a few states. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled
Agri 101: Fruits & vegetables—Cost inflation dated October 7, 2013, “While the Top 10 vegetable producing states contribute 78% of national production, the contribution of West Bengal, Orissa and Bihar is much higher than their contribution to overall GDP. For example, despite being just 2.7% of India’s land area and 7.5% of population, West Bengal produces 19% of India’s vegetables, dominating the production of potatoes, cauliflowers, aubergines and cabbage. In fact, for almost each crop, the four largest states are 60% or more of overall . In particular, Maharashtra dominates the onion trade (45% of national production by value), while West Bengal produces 38% of India’s potatoes, 49% of India’s cauliflower and 27% of India’s aubergines (brinjal). ”
The same stands true for fruits as well. As the Credit Suisse analysts point out “Maharashtra (MH) dominates citrus fruits (primarily oranges), Tamil Nadu (TN) produces nearly 40% of India’s bananas, Andhra Pradesh (AP) is Top 3 in all the three major fruits, and Uttar Pradesh (UP) produces a fifth of India’s mangoes.”
Hence, the production of vegetables as well as fruits is geographically concentrated. What this means is that if there is any disruption in supply, there is not much that can be done to stop prices from goring up. Given the fact that the production is geographically concentrated, hoarding is also easier. Hence, it is possible for traders of one area to get together, create a cartel and hoard, which is what is happening with onions. (
As I argue here). There is nothing that the RBI can do about this. What has also not helped is the fact that the demand for vegetables has grown faster than supply. As Mishra and Shankar write “Supply did respond, as onion and tomato outputs grew the most. But demand rose faster, with prices supported by rising costs.” Hence, even if food inflation moderates, there is very little chance of it falling sharply, feel the analysts.
This is something that Sonal Varma of Nomura Securities agrees with. As she writes in a note dated November 12, 2013 “
On inflation, vegetable prices have not corrected as yet and the price spike that started with onions has now spread to other vegetables. Hence, CPI (consumer price inflation) will likely remain in double-digits over the next two months as well.” The consumer price inflation for the month of October was declared a couple of days back and it was at 10.09%.
Half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). The rise in food prices over the last few years, and the high consumer price inflation, has firmly led people to believe that prices will continue to rise in the days to come. Or as economists put it the inflationary expectations have become firmly anchored. And this is not good for the overall economy.
As Varma puts it “For a sustainable decline in inflation to pre-2008 levels, the vicious link between high food price inflation and elevated inflation expectations has to be broken. The persistence of retail price inflation near double-digits for over five years has firmly anchored inflationary expectations at an elevated level. The role of monetary policy in tackling food price inflation is debateable.”
What she is saying in simple English is that there not much the RBI can do to control food inflation. It can keep raising interest rates but that is unlikely to have much impact on food and vegetable prices.
Varma of Nomura, as well as Mishra and Shankar of Credit Suisse expect food inflation to moderate in the months to come. But even with that inflation will continue to remain high.
As Varma put it in a note released on November 14, “
Looking ahead, we expect vegetable prices to further moderate from December, which should lower food inflation. However, this is likely to be offset by other factors. Domestic fuel prices remain suppressed and the release of this suppressed inflation (especially in diesel) will continue to drive fuel prices higher. Also, manufacturer margins remain under pressure and hence the risk of further pass-through of higher input prices to output prices, i.e., higher core WPI inflation, is likely.”
What this means is that increasing fuel prices will lead to higher inflation. Also, as margins of companies come under threat, due to high inflation, they are likely to increases prices, and thus create further inflation.
All this impacts economic growth primarily because in a high inflationary scenario, people
have been cutting down on expenditure on non essential items like consumer durables, cars etc, in order to ensure that they have enough money in their pockets to pay for food and other essentials. And people not spending money is bad for economic growth.
If India has to get back to high economic growth, inflation needs to be reined in. As Rajan wrote in the 2008
Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation.” The trouble is that there is not much that the RBI can do about it right now.

The article originally appeared on www.firstpost.com on November 14, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)


Inflation at 8 month high is a sure spoiler to FM’s ‘all is well’ party

InflationVivek Kaul  

All is well, again.
Or so the government of India has been trying to tell us over the last few weeks.
But some spoilers have come in lately.
The wholesale price inflation (WPI) for the month of September 2013 has come in at an eight month high of 6.46%. It was at 6.1% in August and 5.85% in July.
A massive increase in food prices has been a major driver of wholesale price inflation. Onion prices rose by a massive 323% in September in comparison to the same period last year. Vegetable prices went up by 89.37%. Fruits were up at 13.54%. And all in all food prices were up by 18.4% in comparison to the same period last year.
Half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). Given this, the massive rise in food prices, hits what the Congress led UPA calls the 
aam aadmi, the most.
In this scenario it is more than likely that the 
aam aadmi has been cutting down on expenditure on non essential items like consumer durables, in order to ensure that he has enough money in his pocket to pay for food.
Hence, it is not surprising the index for industrial production, a measure of the industrial activity in the country, rose by just 0.6% in August 2013, after rising by 2.8% in July.
As Sonal Varma of Nomura writes in a research note dated October 11, 2013 “
consumer durables output growth remained in the negative, possibly due to a sharper slowdown in white goods production.” Consumer durables output fell by 7.6% in August 2013. This after falling by 8.9% in July.
What this tells us clearly is that as people are spending more money on food, they are postponing other expenditure. This postponement of consumption is reflected in companies not increasing the production of goods, which in turn is reflected in the overall index of industrial production rising at a very slow pace and the consumer durables output falling by a whopping 7.6% in August 2013.
The government of India wants to tackle this by increasing the capital of public sector banks in the hope that they give out loans to people to buy consumer durables and two wheelers at lower interest rates. (Why that is a bad idea
 is explained here).
But the trouble is that people are not in the mood to buy stuff because 
they do not feel confident enough of their job prospects in the days to come. As Varma put it in a note dated October 3, 2011 “The job market and income growth – the key drivers of consumption – remain lacklustre.”
Over and above that there is high food inflation to contend with.
One reason that the inflation will continue to remain high is the fact that the government of India has been running a high fiscal deficit. In the first five months of the year (i.e. the period between April-August 2013) the fiscal deficit stood at 8.7% of the GDP. The government is targeting a fiscal deficit of 4.8% of the GDP during the course of the financial year. Fiscal deficit is the difference between what a government earns and what it spends.
As economist Shankar Acharya put it 
in a recent column in the Business Standard “In the first five months of 2013-14, the Centre’s fiscal deficit ratio has been running at a whopping 8.7 per cent of GDP. Bringing it down to 4.8 per cent in the remaining seven months looks impossibly difficult, without recourse to seriously creative accounting ploys. In any case, it is worth pointing out that a deficit that stays high through most of the year imposes the associated costs of higher inflation, higher interest rates, more crowding out of private investment.”
With the government running a higher fiscal deficit it needs to borrow more money to finance the deficit. This means that the private sector will have lesser money to borrow(i.e. it will be crowded out by the government) and hence, will have to offer higher interest rates to borrow money. Hence, the interest rates will continue to remain high.
Also, a higher fiscal deficit means increased government spending in some areas of the economy. This leads to more money chasing the same amount of goods and services and hence, higher prices i.e. inflation.
When interest rates as well as inflation remain high, people are likely to concentrate on consuming things that they need the most, like food and avoiding other expenditure. This will have an impact on economic growth. Hence, the only way to revive economic growth is to weed out inflation. And that’s easier said than done.
This recent confidence of the government has come from the fact that the rupee which had almost touched 70 to a dollar, is now quoting at around 61.2 to a dollar.
This has happened because the government has taken steps to squeeze out gold import totally. In the month of September the gold imports fell to around $0.8 billion. In August, the gold imports were at $0.65 million.
Gold is bought and sold internationally in dollars. Hence, any gold importer needs dollars to buy gold. To buy these dollars the importer needs to sell rupees. And this pushes the value of the rupee down against the dollar.
But with the government making it very difficult to buy gold, the importers are not buying dollars and selling rupees. And this has helped the rupee to recover partially, given that the demand for dollars in the official foreign exchange market has gone down.
Of course these numbers do not include the gold that is now being smuggled into India. While there is no specific data available for this, there is enough anecdotal evidence going around. As Dan Smith and Anubhuti Sahay of Standard Chartered write in a report titled 
Gold – India’s government gets tough “Pakistan temporarily suspended a duty-free gold import arrangement in August, when gold imports doubled. According to media reports, much of this was crossing the border into India. Dubai has seen a steady pick-up in the number of passengers being arrested at airports for smuggling. Nepal has seen an eight-fold rise in smuggling – 69kg of smuggled gold was seized by customs in the first half of this year, versus 18kg for the whole of 2012.”
This does not reflect in the official numbers and there are other social consequences of smuggling. It is worth remembering that Dawood Ibrahim started out primarily as a gold smuggler, until he moved onto other bigger things.
The other factor that has helped control the value of the rupee against the dollar is the fact that oil companies are buying dollars directly from the Reserve Bank of India and not from the market. Hence, the two major buyers of dollars in the foreign exchange market have been taken out of the equation totally. This has skewed the equation in favour of the rupee.
Of course this cannot continue forever. Some demand for gold is likely to return in the months of October and November, because of the marriage season as well as Diwali. The other decision that has helped the rupee is the fact that the Federal Reserve of United States has decided to continue printing money.
While it is widely expected that the Federal Reserve will continue to print money in the months to come, this is something that is not under the control of the Indian government. Also, it is worth remembering that given the high fiscal deficit, the threat of India being downgraded to “junk” status by an international rating agency remains very high. If this were to happen, many investors will exit India in a hurry, putting pressure on the rupee, and undoing all the work that has been done to get it back to a level of 61 against the dollar.
In short, the macroeconomic conditions of India continue to remain weak, despite the government trying to project otherwise.

The article originally appeared on www.firstpost.com on October 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)