Inflation dilemmas

When it comes to inflation, public perception is political reality. While the inflation rate as measured by the wholesale price index (WPI) has been steadily rising over the past few months, it remains quite moderate at 5.44 per cent as of June 17. However, as far as the government is concerned, the increasing public outcry and a re-invigorated opposition are enough to warrant quick and decisive action. The Reserve Bank of India governor, Y V Reddy, has of course gone on record saying that this number understates the true rate of inflation because the full impact of rising oil prices has not yet been passed on to the consumer.

Against the backdrop of an overall rate of 5.44 per cent, it is quite easy to see what is driving the increase, but not as easy to find a solution. On the one hand, prices for the category "fuel, power, light and lubricants" have increased by almost 10 per cent over the corresponding week of the previous year. On the other hand, prices of pulses have increased by over 35 per cent, maintaining the clip of the last six weeks, while vegetable prices have increased by 17 per cent, the third week in a row with double-digit numbers. Since these are all items that affect the household budget (falling air fares are no compensation!), it is easy to see why prices have become a political issue.

So what is to be done? Very little can be done about energy prices, particularly since their full costs haven't even been passed on. Adjustments to central, state and local taxes will partially mitigate the impact, but those have already been made and there isn't much room left. Monetary management by the RBI has taken on an increasingly aggressive anti-inflationary stance over the past few months and this will help to moderate inflation in the coming months, but the macro-economic tool-kit is hardly designed to deal with exploding prices of pulses and vegetables. The immediate solution to this problem has to be focused directly on the problem commodities themselves.

The Congress Working Committee and chief ministers' meetings over the last couple of days addressed the issue. Reports suggest that their solutions, while recognising the micro-economic nature of the problem, will resort to principles that have been proven failures in the past. Commodity futures markets increase price volatility, so ban them. Liberal movements of food items across state boundaries facilitate "hoarding and profiteering", so go back to the tight controls enshrined in the Essential Commodities Act. If implemented, these measures will, at one sweep, roll back substantial reforms in agriculture that were so painstakingly achieved. They may solve the problem in a limited way in some pockets but, over time, will compound it by undermining the incentives that farmers have to grow the very items that are causing the problem today.

Of course, one way to deal with the problem is to just wait it out. Prices of food items tend to adjust very quickly, particularly with the monsoons under way. Vegetable supplies will respond very fast. However, with pulses, the room for manoeuvre is rather limited. Since the government doesn't stock pulses, it cannot release stocks into the market to dampen prices. The situation is compounded by a global shortage in pulses, so imports will not help to bring down prices. Work needs to begin on a viable medium-term solution, which combines market incentives with credible means of intervention, but until then the government can only pin its hopes on the monsoons.