“We live in this peculiar world where three per cent inflation is stability but a half per cent decline in the price index is deflation. I am not quite up with modern nomenclature.” — Paul Volcker
The country has lived with inflation for about one and a half years. During 2010-11, the rate of price increase was nine per cent. There has been no respite since then and it has been a roller-coaster ride. Every time there is a decline of a few decimal points in the rate, hosannas are sung in official circles, which pats its own back for the achievement.
What is worrisome is the government’s somewhat laid-back attitude towards inflation. By the middle of June 2010, the official circles expressed satisfaction with the fact that food inflation had “stabilised” at around 16 per cent. If there is a rise then the base effect is blamed! Since the mid-eighties, the Reserve Bank of India (RBI) has formulated its monetary policy on the assumption of an “acceptable” price rise of five per cent. The rationale is that in the course of economic development certain sectors will grow, while others will decline, thus shifting resources from the latter to the former that would give rise to a general inflation rate of five per cent. It did not produce any study to support its conclusion. I have refuted this fallacious argument elsewhere. Otmar Issing, member of the European Central Bank’s Executive Board, once said: “For the relative price mechanism to function properly, firms must be able to discriminate between relative price adjustments and general changes in the overall price level. They can only be sure of not making mistakes in a situation of overall price stability.”
The latest is the talk about 6.5 per cent being the new normal for price rise! The next “logical” argument will probably be that everything is fine till the time there is no double-digit inflation and it is contained at 9.9 per cent! And then you have experts saying a little inflation is good for developing the economy. It is as absurd as saying a little pregnancy is good for a woman. To add insult to injury, the goal post for a reduction in inflation is moved from time to time. From kharif 2009 it was moved to rabi 2010 and then again to the next kharif and so on.
The whole concept of a “tolerable” or “acceptable” inflation rate of five per cent, adumbrated by the authorities, is misplaced. Was any opinion survey conducted or was there a discussion in Parliament on the concept affecting more than a billion people? There are a number of reports of restaurants in Mumbai closing for lack of customers. And this is the case in perhaps the country’s richest city in terms of average income. Then there are stories of families cutting down on their consumption of milk, coffee, tea, vegetables and fruit and housewives foregoing the weekend luxury of going to a restaurant with the family for dinner instead of cooking at home. There’s much research on the reduction of the proportion of people below the poverty line. Now, it is time to find out about the neo-poor, which are people formerly above the poverty line but have since gone below it due to inflation.
There are reasons for the developed countries having a threshold for inflation at two-three per cent. First, the consumer price index is somewhat biased upwards because it does not take into account the improvements in the quality and performance of manufactured goods. Second, the West is worried more about deflation than inflation because there are no effective policies to tackle the former. Third, the number of people below the poverty line is not much compared to us. Fourth, most families have working couples with double incomes, so they can afford to bear a price rise of two to three per cent. These considerations do not apply to a country with a large number of poor people for most of whom food is the most important item in the family budget. With massive Five-Year Plans and large-scale fiscal deficits, the question of a general deflation is not likely to arise.
There are experts who say the RBI and the government should focus on the core, rather than headline, inflation. The former refers to the inflation excluding food and fuel items, while the latter includes all the commodities. This is a case of adopting Western concepts, either unknowingly or deliberately, without recognising the ground realities in the country. In the US, the concept of core inflation developed for two reasons: first, because of the volatility of food and fuel prices that was unrelated to monetary factors and, second, their relative low weights (13.378 per cent and 4.525 per cent, respectively) in the price index. It helped isolate non-monetary factors for policy-making. Further, the Consumer Price Index for the US is for the urban population. These factors do not hold good for India. In fact, our core sector should include only food and fuel.
One hopes that in the next quarterly review of its monetary policy, the RBI will take a hard look at its past assumptions and modify them with the sole objective of fighting inflation. We need a Paul Volcker to squeeze inflation out of the economy.
The author is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at the Reserve Bank of India
