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Millennium Post

Common man's guide to inflation

Say what you will, but the inflation rate, at last, is falling. That is according to official figures. You might say you are still paying slightly more for whatever you buy. But a falling inflation rate does not mean falling prices as if you are paying less for what you buy, but only that rise in prices is somewhat slower. This is a common mistake that people often make when inflation rate is said to be falling and the average man in the street says that he is paying more.

Let me illustrate. In times of high inflation, it might be that you say Rs 30 for a kilogram of rice on 1 June this year. By say August 1 next year, you are paying Rs 38 to Rs 40 for the same kg of rice. In times of falling inflation rate, you will pay just about Rs 32.50 to Rs 33 for a kg of rice by 1 August. This little price is rise is good. Because falling prices means for the economy what falling blood pressure is for the body. In case, blood pressure keeps falling a patient collapses and organs pack up. Economists call this ‘deflation’ and fighting deflation is far more complicated and difficult than fighting inflation. Why? Because in a deflationary situation consumers tend to defer their purchases, hoping that prices should fall further. When the community of consumers does not buy, factories are saddled with unsold stocks, they close down. The worst such experience of deflation was in Japan. For a whole decade, Japanese prices fell by and by and the economy sank. This period in Japan’s economic history in the 1990s is called the ‘Lost Decade’ when Japan did not grow while the rest of the global economy was growing.

For a developing economy, a little bit of inflation is necessary to encourage producers to produce and investors to invest. This is in effect a driver of growth. At the same time, runaway inflation is equally bad in that it destroys all calculations. Once again, the worst case of hyper-inflation was in Germany in the 1920s when the German mark was so devalued that cartloads of currency would be required to make ordinary home purchases.

We are safe from both these extremes, thanks to our institutional set up. We have the Reserve Bank as the guardian of prices. We have the government always afraid of losing vote if prices rise too fast. Recall when Indira Gandhi lost elections because of rising onion prices. Economists might frown and say, like the famous detective Sherlock Holmes: elementary, my dear Watson, elementary’. ‘But it is important to remember these fundamentals to get the grips about inflation. Having set right that confusion about inflation, let us take a quick look at the dynamics of price rise, as reported by the official release.

The annual rate of inflation, based on monthly WPI, stood at 4.70 per cent (provisional) for the month of May 2013 (over May 2012) as compared to 4.89 per cent (provisional) for the previous month and 7.55 per cent during the corresponding month of the previous year. Build up in inflation rate in the financial year so far was 0.88 per cent compared to a build up rate of 1.80 per cent in the
corresponding period of the previous year. Food prices inflation continued unabated with wheat prices rising by 12.65 per cent, rice by 18.48 per cent and cereals by 16 per cent. Potato prices declined while onion prices spiked by 97.40 per cent compared with the same month last year. Manufactured products inflation remained subdued at 3.11 per cent. With this core inflation remains close to two per cent and far below the tolerable limits of RBI. Basic metals and minerals, iron and semis prices fell indicating softness in industrial demand.

But what the price figures are showing? The WPI figures indicated falling inflation rate, but if you go behind the figures these reflect overall slowdown in the economy. How? If you look at the inflation figures for upstream and basic industries – the foundation of an economy – these prices are softening month after month. When industrial activity is going down, the demand for these is slackening. Hence, their prices are falling. Link up these figures with those of the Index of Industrial Production (IIP) and you will get a vindication of this assumption. Mining and metals industries are showing no growth. They are often shrinking. Along with that the investment rate in the economy is falling.

It is here that all these figures – released this week – show an action programme. It becomes almost inescapable to bring down interest rates now. The RBI might as well decide to cut the interest rates to give a little boost to the economy. That’s we have been driving at. IPA
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