As inflation rises every rupee will buy a smaller percentage of a good. CAUSES OF INFLATION Cost push theory: Inflation occurs when the cost of producing rises and the increase is passing on to consumer. The cost of production can rise because of a) Rising labour cost or when the production firm is a monopoly or oligopoly and raises prices, cost of imported raw material rises due to exchange rate changes b) External factor: natural calamities or an increase in the economic power of a certain country c) Increase in indirect taxes can also lead to increased production costs.
Demand pull theory: it attributes a rise in prices to increase to an increase in demand in excess of the supplies available. There can be an increase in demand due to: a) Increase in quantity of money in circulation relative to the ability of the economy. b) Declining interest rates cut in tax rates or increased consumer confidence increases the money supply in the economy. Artificial creation: inflation can be artificially created through a circular increase in wage earners demands and then the subsequent increase in producer costs which will drive up the prices of their goods and services.
This will then translate back into higher prices for wage earners or consumers. As demand increases from each side, inflation continues to rise. Deficit of federal government: if money supply is increased to keep the interest rates down, they federal deficit contributes to inflation. If the debt is not monetized, some borrowers will be crowded out if the interest rates rise. This results in an impact on output and employment than on the price levels. EFFECTS OF INFLATION •The worth of the money will reduce as time and inflation goes on. Increase in prices of goods and services – the most visible effect •Decrease in real income •It encourages oarding – as people anticipate a rise in prices •Alters the distribution of income. •It can lead to a wage spiral – people will demand higher wages to cope with increasing prices and increased wages will push the prices further up •Lowers the domestic savings rate since people prefer to spend money rather than watch it diminish in value •When inflation becomes evry acute, it may lead to hyper inflation which is disastrous for any economy.
Apart from these, inflation has some positive effects too. These are :- •Relief from debt – if you had taken a loan at a fixed rate of interest, despite inflation, you will continue to pay the same interest to your creditor which actually implies a fall in the real interest that you are paying, though the nominal rate may be the same. •Increase in investments – when people realise that the value of money is decreasing, they try to invest it in an asset which would yield higher income, such as real capital assets. This is also called the Tobin Effect. MEASURES OF INFLATION
The inflation in the Indian economy can be measured in 3 ways: 1) National Income Deflator- This is defined as ratio of GDP at current prices and GDP at Constant Prices. It is a comprehensive measure as it encompasses all the goods and services produced in the economy. However, its application is limited as it is released on a quarterly basis by CSO and then it comes with a lag of 2 months (e. g. figures for quarter Jan-Mar 2008 quarter are released on 30 May, 2008). Further the GDP figures are subject to revisions (though this applies to WPI as well) and together these factors make it of little use for policymakers. ) Based on Wholesale Price Index (WPI)- This is the most common measure of inflation and is used for policy purposes. 3) Based on Consumer Price Indices- Within Consumer Price Indices, there are four subindices that are based to capture price levels across different types of consumers. They are: a. CPI – Industrial Workers b. CPI- Urban Non-Manual Employees c. CPI- Agricultural labor d. CPI- Rural Labor So how does India calculate inflation? And how is it calculated in developed countries ? ?India uses the Wholesale Price Index (WPI) to calculate and then ecide the inflation rate in the economy. ?Most developed countries use the Consumer Price Index (CPI) to calculate inflation. Consumer price index The Consumer Price Index, or CPI, is a monthly measurement of inflation. It reports on the price changes of 80,000 items that represent a cross-section of goods and services purchased by urban households. The CPI is measured monthly by the Bureau of Labor Statistics (BLS). The agency collects price information from 23,000 retail and service businesses. The businesses chosen are the types frequented by a sample of 14,500 families.
The CPI includes sales taxes, but excludes income taxes and the prices of investments such as stocks and bonds. Why the CPI is Important: CPI measures inflation, which is one of the greatest threats to a healthy economy. •It is used by the Federal government to determine whether economic policies need to be modified to prevent inflation. •The CPI is used to adjust prices in other government economic indicators, such as Gross Domestic Product, or GDP. •the index is used to adjust benefit levels for recipients of Social Security and other government programs THE WHOLESALE PRICE INDEX
The Wholesale Price Index is the price of a representative basket of wholesale goods. The Wholesale Price Index focuses on the price of goods traded between corporations, rather than goods bought by consumers, which is measured by the Consumer price index. WPI was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market.
In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks. The Indian government has taken WPI as an indicator of the rate of inflationin the economy. The Indian WPI figure is released weekly on every thursday and influences stock and fixed price markets. The purpose of the WPI is to monitor price movements that reflect supply and demand in industry, manufacturing and construction.
This helps in analyzing both macroeconomic and microeconomic conditions. FOOD PRICE INFLATION By definition, food inflation is exactly what it seems. Consumers are now paying more for inflated food prices. In other words, if your monthly grocery budget was $4000 a year ago, you are now likely paying closer to $7000-plus, buying exactly the same products. The years 2007–2008 saw dramatic increases in world food prices, creating a global crisis and causing political and economical instability and social unrest in both poor and developed nations.
Initial causes of the late 2006 price spikes included droughts in grain-producing nations and rising oil prices. •Newspapers have cited that 75% of the price increase was due to biofuels. •Several governments and commentators see speculation as a major driving force. •A widely held view has it that rapidly growing food demand in the emerging economies is pushing up global food prices. 1)The use of agricultural products, in particular maize, wheat, and vegetable oil, as feedstock for biofuel production has expanded dramatically in recent years. Between 2005 and 2007, i. e. n the period when food prices began to explode, nearly 60% of the growth in global consumption of cereals and vegetable oils was due to biofuel. The land that was used to produce food crops was now being used to grow maize for biofuels. 2)Food demand in China, India, and other emerging economies is rising as their incomes grow. However, domestic food production in most of these countries is growing in parallel. As the middle class is growing so is the consumption of food. The increase in income for the middle class is leading to excess disposable money with them. Though this only cannot be the only reason for food inflation. )OECD analysis clearly shows that two factors external to agriculture and food have had, and will continue to have in the years to come, a significant impact on the rise of global food prices. The rapid increase in crude oil prices and energy prices more generally has significantly raised the costs of producing and shipping agricultural products. The weak dollar has contributed to driving up dollar-denominated commodity prices in international trade. The Indian Perspective World food prices have been showing an upward trend since 2008 due to structural and cyclical changes.
India is not an exception of that. Food Prices have become one of the most important topics in India over the last 2 years. A Deficient Monsoon season in 2009 was the primary cause of a sharp rise in Food Prices leading to Food Insecurity for a majority of the lower agricultural growth in India compared to the much faster GDP growth India is currently experiencing one of the highest inflationary episodes in the history of the country. This is evident in the graph given below. This is how food prices have risen since 2007: •Food articles: 7. 02% (in 2007) to 17. 41% in January 2010. Food products: 3. 43% (in 2007) to 22. 55% in January 2010. •Food commodities: 5. 60% (in 2007) to 19. 42% in January 2010. •Foodgrains: 6. 27% (in 2007) to 17. 89% in January 2010. •Cereals: 6. 27% (in 2007) to 13. 69% in January 2010. •Pulses: 2. 14% (in 2007) to 45. 62% in 2007 in January 2010. •Rice: 6. 05% (in 2007) to 12. 02% in January 2010. •Wheat: 6. 77% (in 2007) to 14. 86% in January 2010. •Dairy products: 6. 08% (in 2007) to 12. 87% in January 2010. •Eggs, fish and meat: 6. 38% (in 2007) to 30. 71% in January 2010. •Sugar: (-)14. 69% (in 2007) to 58. 94% in January 2010
Inflation in Food and Non-food Commodities during 1994-95 to January 2010 (Based on WPI with base 1993-94) and Growth Rate in Food Output (%) Item1994-95 to 2004-05200520062007200820092010 JanuaryAverage 2006-09 1. All commodities5. 904. 744. 824. 829. 122. 018. 545. 19 2. Non-food commodities6. 025. 374. 724. 549. 55-1. 764. 534. 27 3. Food articles5. 913. 946. 837. 026. 6412. 3217. 418. 20 4. Foodproducts5. 331. 582. 553. 439. 8013. 7922. 557. 39 5. Food commodities 5. 642. 975. 095. 607. 8712. 9019. 427. 86 Food grains5. 543. 839. 716. 276. 3714. 1417. 899. 12 Cereals5. 573. 686. 636. 77. 2012. 9613. 698. 44 Pulses5. 465. 0432. 052. 141. 3021. 8145. 6214. 33 Rice5. 004. 012. 136. 058. 9715. 9612. 028. 28 Wheat5. 931. 0812. 996. 775. 066. 8314. 867. 91 Oilseeds5. 89-6. 11-3. 9626. 5817. 460. 9210. 0510. 25 Fruits and vegetables7. 477. 512. 246. 495. 9411. 778. 336. 61 Dairy products5. 200. 114. 206. 088. 386. 1212. 876. 19 Milk group5. 570. 734. 488. 177. 878. 9313. 997. 36 Egg, fish and meat6. 469. 466. 726. 383. 7514. 4430. 717. 82 Edible oils4. 85-7. 191. 2313. 1112. 52-6. 59-1. 175. 07 Sugar4. 0615. 094. 83-14. 75. 6236. 3458. 948. 02 Growth in food output(%/a yr)2. 90. 555. 874. 105. 391. 60-02 AE4. 24 Currently, on the week ending November 6, 2010, the year-on-year food inflation rate, as measured by the Wholesale Price Index was 10. 3% rising from 12. 6% in the previous week. Though this number has come down by 2 percentage ponts to a three-month low, absolute level of prices do not seem to be coming down. These are the food prices that have gained in 2010. Not all food articles gained prices though, some things went down also. This double digit inflation rate for food articles has been persisting for a long period of time since last year.
It was told by the government and other policy makers that inflation was mainly in the food articles because of the last year’s drought. Once the kharif crop is harvested, supply will get augmented and hence the food inflation rate and the overall inflation rate will come down. This has not happened. The overall inflation rate for the month of May 2010 was 10. 16%, rising from 9. 59% in April 2010. What is even more worrying is that not only is it the case that food price inflation is rising but additionally inflation rate for manufactured articles has also increased in May 2010 to 6. 1%, which was only 2. 18% in May last year. Clearly then, belying the expectations of the UPA government and the policy makers, inflation is even now on the rise. The question is why? CAUSES The key reasons cited for spiralling food prices in India are :- 1. Rising percentage of Middle Class in India which is demanding increasing quantities of better quality food products. With increasing incomes, people prefer to eat more meat which is more food grain intensive than a vegetarian diet 2. High general Inflation is also a contributor to higher Food Prices 3.
Inefficiency in the Food Supply Chain. India wastes a huge amount of Food due to an antiquated supply structure which involves middlemen and mandis. These middlemen add no value and lead to higher retail prices for food besides indulging in hoarding practices. Foreign investment in the Retail area has been prevented by these vested interests. 4. Dependence of Indian Agriculture on Monsoon Rains. India’s low investment in Irrigation has implied that a majority of the crop growing areas are dependent on seasonal rains. This was brought out starkly when Monsoon Rains failed in 2010.
As said before, the main reason cited by the government was the severe drought of 2009, which was one of the worst ever in Indian history. This drought resulted in the failure of the Kharif crop which then led to an increase in the food prices. So it was expected that with the harvest of next season’s crops, the inflation would come down. But that didn’t happen, in fact the food price inflation rates have been in double digits since more than a year now. So, in view of that, it is evident that bad monsoon and a failed crop cannot be the only reason for spiralling food prices. We need to look deeper to find out the reasons for that.
Now we take a look at those. Inflation is caused by an excess demand of commodities. This excess demand can happen in two alternative ways. Firstly, when there’s an increase in demand with the supply remaining constant. Secondly, the demand remains constant but the supply falls. So when there’s shortage of supply, the prices will rise leading to inflation. The second instance is what happened in India. When the policies of neo-liberal globalisation were implemented, the growth rate of food grains started declining and ever since then there has been a steady decline in the growth rate of food grains.
During 1993-94 to 2003-04, the growth rate of food grains was only . 69% which further reduced to . 32% in 2003-04 to 2009-10. But why is the supply of food grains or the growth rate of food grains lagging? The reasons for that could be : a)First, there is the impact of high oil prices, which affect agricultural costs directly because of the significance of energy as an input in the cultivation process itself (through fertilizer and irrigation costs) and in transporting food.
Across the world, governments have reduced protection and subsidies on agriculture, which means that high costs of energy directly translate into higher costs of cultivation and therefore higher prices of output. b)Second, there is the impact of both oil prices and government policies in the U. S. , Europe, Brazil and elsewhere that have promoted biofuels as an alternative to petroleum. This has led to significant shifts in acreage as well as use of certain grains.
For instance, in 2006, the U. S. diverted more than 20 per cent of its maize production to the production of ethanol, Brazil used half of its sugarcane production to make biofuel, and the European Union (E. U. ) used the greater part of its vegetable oil production as well as imported vegetable oils to make biofuel. This has naturally reduced the available land for producing food. c)Third, the impact of policy neglect of agriculture over the past two decades is finally being felt.
The prolonged agrarian crisis in many parts of the developing world; the shifts in acreage from food crops to cash crops relying on purchased inputs; the excessive use of groundwater and the inadequate attention paid to preserving or regenerating land and soil quality; the lack of attention to relevant agricultural research and extension; the overuse of chemical inputs that have long-run implications for both safety and productivity; the ecological implications of both pollution and climate change, including desertification and loss of cultivable land: all these are issues that have been highlighted by analysts but largely ignored by policymakers in most countries. Reversing these processes is possible but will take time and substantial public investment, so until then global supply conditions will remain problematic. Now the issue is that the population growth rate of india is around 1. 4%. So evidently, there is some disparity here. A population growth rate of 1. 4% and a food grain growth rate of only . 32% ! obviously there will be shortage of supply of food grains in the economy.
This essentially implies that the per capita food grain production in India is far below the required level and is declining further. Simultaneously, what is happening is that India is experiencing high levels of growth. The GDP for 2009-10 was 9%. A great figure considering the recession in the world and the conditions of other countries. With this growth, the standard of living of all classes, especially the middle income group is increasing. So their demand for food grains is also increasing. So the shortage of supply combined with the excess of demand implies a tremendous shortage of food grains. This is reflected in the high inflation in the country.
While the slowdown in the food grain production in particular and the agriculture sector in general is the main structural cause behind the persistent high food inflation in the country, this process is aptly aggravated by speculation in the commodity market. The government, in accordance with its pro-market economic policy has allowed future trading in commodity markets. This is nothing but an euphemism for speculation. Suppose there exists inflationary expectations in the market. Therefore, a seller of commodities will prefer to hoard food-grains rather than sell it currently, in the lure of a still higher price in the future. This in turn creates shortages in the market at present, which again results in inflation.
By legalizing such speculative activities, the government is only benefiting speculators at the cost of the common people. The other reasons are :- •In 2008, it was estimated that India loses INR 58,000 crore worth of agricultural food items due to lack of post harvesting infrastructure such as cold chains, transportation, and storage facilities. If the Government ensured proper storage facility, food inventory would have been more than sufficient leading to prices remaining under control. •The Indian farmers are largely dependent on the four-month monsoon season during which 80% of the year’s total rainfall takes place. The reason is that 60% of the country’s total cropped area is not irrigated. The Government has again been alking about inclusive growth and stress on rural India. These facts don’t point to any meaningful efforts to help farmers in a country where over 10,000 farmers have committed suicide over the last decade. •The per hectare agricultural yield in India is half that of China. This again points of inefficiency and the failure to help the farmers adopt latest technology in order to increase the crop output. These things have not been taken care of in the past and even when discussed, nothing substantial has been done in order to overcome these challenges. Steps need to be taken to ensure minimal food wastage, high crop productivity and increase in irrigated land.
WHAT NEEDS TO BE DONE TO CONTROL FOOD PRICE INFLATION The government, to control food price inflation can take either fiscal or monetary measures. Fiscal measures: The government is now focussing on controlling the interest rates to keep the debts low and reduce the deficits. All these things if attained leads to a more open. Just to cover the debt the whole burden cannot fall on taxes only, therefore the govt should use a better approach which is actually reducing its wasteful expenditure. Monetary measures: A sharp rise in interest rates has severe consequences. The knowledge of future rise will reduce inflationary expectations, if combined with action to reduce costs.
A short-term nominal exchange rate appreciation reduces costs. This can be very useful to contain a temporary spike in oil or food prices and will become more effective as petrol prices are free and food prices reflect border prices These measures should be implemented together for the better functioning of an economy and the problem of food security can be controlled. They will help to curb the spiralling food prices in the short run and will set the grounds for tackling such challenges and achieve the Indian government’s growth targets in the long run. The resources so saved can be ploughed back to agriculture through investments in research and rural infrastructure, which give much higher returns.
The following are the steps for an immediate reform: •To release the stock India has so that it helps in sustaining the rise in price gains. • State government should take effective action against hoarders and black marketers •A part of India’s foreign exchange reserves can be used for bulk import of essential commodities like pulses, fruits and vegetables etc. For Medium to long term Reforms, the steps that need to be taken are. 1. Improvement in the production of food: Although the yield per hectare of food grains has shown some improvement in the recent years it is not significant enough to cater to the needs of the rising population particularly when income levels are also rising.
Special attention should be given to states with relatively low productivity. 2. Even though the country has build up strategic reserves of wheat and rice in the last few years but the problem of storage, efficient food stock management, and offloading of stocks still remains. 3. Another thing to be considered is that pulses should be a part of the buffer stock maintained by Government as it is in the case of Rice and Wheat. 4. Promoting Private sector Participation in Food grain Management: Complementary changes to the food pricing policies are required to ensure that the above enabling changes do result in greater private sector participation.
Private marketing should be strengthened through reforming the Agricultural Produce Marketing Committees (APMC) Act, abolishing the Essential Commodities Act (ECA), abolishing rice levies, permitting direct purchases from farmers, eliminating movement and storage controls, facilitating warehouse receipts, strengthening futures markets, and opening imports and exports to the private sector. 5. It is necessary for the private sector to participate to cater the infrastructure need. Private investment/public private partnership requires policy support from the Government both in terms of creating legal environment, stable policy perspective and financial incentives. 6. The water abundant areas such as North East should be used to their potential to get the best results in case of food. 7. Improving investments: Eventually India will have to invest more in agriculture to be able to meet the objective of food security of a growing population.
Subsidies if needed should be channelled directly to the channelled groups. 8. Legislation of tenancy: The interest of small farmers should be kept in mind by providing leasing in and leasing out land. Liberalization of agricultural tenancy would promote diversified agricultural growth, better utilization of land and increase farm output. It will also increase the mobility of people from the rural to urban areas and improve the availability of land in the land lease market. The legalisation of tenancy is expected to give rise to long-term tenancy contracts, which would offer more incentives to the tenants for undertaking productivity enhancement measures. 9.
Liberalization: Marketing and trade policies should be liberalized to encourage the coordination between farms, firms and supermarkets. CONCLUSION For the first four months of fiscal 2010-11, the quarterly food inflation rates have looked very similar to those that prevailed in 2009, which as we have seen was a bad year in terms of agricultural output. However, since late August the pattern appears to have changed, and the pattern of price movements much more closely tracks the price behaviour of 2007, which was a good harvest year. Since all indications are that the current year will witness a good kharif harvest, there is sufficient reason to expect that the quarterly inflation rate may turn negative post-harvest, as had occurred in 2007 for example.
If this does actually transpire, then it may well be that the rate of food price inflation will decline in the near future. Chart 4 projects the price behaviour noted from Chart 3 onto the coming months of this year, in terms of the possible implications for the year-on-year food inflation rate. If the seasonal price pattern tracks the movements in 2007, which may be expected because of the good kharif harvest, there is likely to be a decline in the year-on-year food inflation rate to just below 6 per cent in the coming months. This in turn means that heavy-handed monetary policy measures designed to curb such inflation, especially those affecting the base interest rate, are likely to be excessive and even unnecessary given the likely movement of food prices.
However, this does not mean that there is any justification for complacency on the food price issue, nor does it suggest that the question of food security for the population is any less pressing. Note that much of the decline in food inflation rates that may appear shortly is because of the base effect of very high food prices in the previous year. Also, money wages of most workers (both wage workers and self-employed) have certainly not kept pace with the food price increases. A further factor must be borne in mind. India continues to be affected by global prices of important food items, and there are clear indications of another price upsurge in food markets in global trade.
For example, wheat prices in the Chicago market (which is the typical benchmark for the global trade price) have increased by more than 70 per cent in the three months up to late September. There is once more evidence of speculative activity in the commodity futures markets, driven by index traders. What makes the problem more pressing for India is that the Indian government has once again allowed futures contracts in wheat from May 2009, having lifted the ban specifically for this commodity. If the global speculative pressures affect India, including through the impact on the local futures market, this may provide a source of food price inflation that is unrelated to local supply factors. In such a case, any bets on future food price movements would be off.
