The sharp drop in the inflation rate, as measured by the wholesale price index, to 8.98 per cent on November 1, from 10.72 per cent a week earlier, should set at rest any lingering question about whether the primary economic challenge is inflation or the slowdown. Some might even argue that the danger to be dealt with now is deflation. For while the extent of the drop in the latest week (said to be the sharpest in 18 years) may be a surprise, it was widely expected that the rate of inflation would continue to drop; indeed, the overwhelming evidence at hand had made it more than obvious. All commodity prices had been falling, some of them precipitously, in recent weeks—including oil, steel, a variety of petro-chemicals, and agricultural products like rubber. According to The Economist’s commodity index, commodity prices have fallen by as much as 21 per cent in one month! It was only to be expected, therefore, that inflation would continue to decline. Admittedly, the inflation rate is still well above what it was at this time a year ago (barely 3 per cent), but the Reserve Bank’s year-end target of 7 per cent already looks within reach. Indeed, the March inflation figure could well be in the RBI’s normal “comfort” zone of 5-5.5 per cent.
Ironically, the sudden drop in many prices has become a problem for producers, for many of whom the processing cycle between purchase of raw material and turning out of finished product is long enough for them to get caught in a price bind—the finished product now commands a lower price than the cost of the raw material at the time of its purchase. In the case of steel, the government is even toying with the idea of introducing tariff protection—mirroring the tariff tinkering that was done when steel prices were at their peak, so as to discourage exports and make more steel available at home. It would appear that the government is still some distance removed from accepting that commodity prices should be left alone for industry players to deal with as best they can on both the upswings and the downswings.
Among the many factors influencing prices, the monsoons were good this year, and the kharif crop is now in the market. There is a falling off of consumer demand in many sectors, and slackness in the construction and other sectors—all of which have put a downward pressure on prices. With the International Monetary Fund predicting a worldwide recession next year (the first since the Fund’s creation in 1944), slack demand is likely to remain the order of the day in global markets, and prices are therefore likely to remain soft for the foreseeable future. This scenario reinforces the argument that the danger now is no longer inflation, and could well be deflation.
While government policy should naturally focus on addressing the slowdown, some thought should also be given to the decision to move away from weekly wholesale price index announcements. The argument in recent months has been that the weekly index is misleading because it does not track changes in all items every week, which a monthly index could do. The sub-text was that the weekly announcements of steadily rising inflation were putting pressure on the government. Ironically, however, the monthly consumer price indices (which have been climbing virtually unnoticed) now show higher inflation—that for industrial workers is at 9.8 per cent, and for agricultural labourers 11 per cent! In other words, the political purpose behind abandoning the weekly pronouncements may not be served when the inflation rate is dropping.
