India: Tackling recent surge in inflation

We are witnessing a surge in inflation (in India) and this time the soaring numbers are reflecting the CPI. It would be interesting to see how the government tackles the situation.

The inflation figures are soaring due to rise in prices of food items, primarily potato (136%), pulses (40%), onion (15.4%) and wheat (14%). Supply side constraint has been sighted as the primary reason behind this recent surge. It’s true keeping in mind the draughts and floods that we have faced this year. To add to this, we have a completely unregulated part of supply chain between farmers and retailers where the final mark up at which the consumers pay can go over 500%!

You will get plethora of information describing the current situation on the internet. I wanted to discuss what lies ahead. We now have two primary challenges

1.       Supply side constraints

2.       Artificial price hike due to unreasonable mark-ups and hoarding

And a pseudo challenge of increased money supply (I will explain later why I call it pseudo challenge). 

This one is a special case of inflation where we are witnessing unprecedented rise in food prices. Let’s first keep the artificial price hike aside because it’s an unchartered territory for our Government and surely the Government is incapable of handling the enormity of this challenge. Thus fixing this one is a long shot and let’s not expect this to happen for now.

The second and the pseudo way I believe is monetary policy. If you can’t prop up supply then reduce demand, sounds just right. However, I call it a pseudo solution as tightening monetary policy might not be an intelligent and effective way to tackle rising food prices.

First reason is the tools used for tightening monetary policy like interest rate, CRR, etc would take a very long time to actually affect drop in demand for food items. The trickle down effect is very slow as food lies far down the chain from where monetary policy starts taking effect.

Secondary reason is that the demand for food is still affected much more by consumption rather than investment. This coupled with the wide rich poor divide means that the major chunk of liquidity lies within the reach of rich few, who would not start eating more just because the cost of capital has gone down. Increased liquidity would have increased overall demand for food if the money would have reached the pockets of wider section of society, especially the ones who are consuming far less than a healthy diet. This is why a tightening of monetary policy may not bring in desired results, although it just might give a picture that the Government is at least doing “something”. Although this “something” will surely prove to be a serious blow to the much needed recovery process after the recent credit crunch.

Thus my request would be not to disturb the monetary policy.

Let’s now turn to supply side constraint. The Government nowadays doesn’t shy away from importing food stocks to relieve the pressure on domestic supply. It shows dual benefit, on one hand it strengthens the supply and on the other hand it also forces the hoarders to release stocks due to downward pressure on prices. However, this time the solution would be a bit more tricky. This is due to recent surge in world food commodity prices. Prices of wheat, maize, sugar, et al have witnessed rise in prices. Shortage of supply of sugar from Brazil has pushed sugar prices to touch its 28 yr high. Import decision from India would further put pressure on world prices. Thus import would be expensive for India.


http://www.indexmundi.com/commodities/?commodity=food-price-index

Sorry, I am not suggesting any perfect solution but it would really be interesting to see the next steps. Also, it would again pose fresh questions on our self sufficiency in terms of food produce. 


Is it time to let the INR float freely and appreciate rather than pegging against USD? Have a look here to read more about this http://bhasker-siddharth.blogspot.com/2009/08/american-recession-fuelling-domestic.html