Inflation fires burning
Inflation - a phenomenon which affects one and all. The variation in the price level in India can be measured in terms of the Wholesale Price Index (WPI), or the Implicit National Income Deflator (NID) or the Consumer Price Index (CPI). The WPI is the main measure of the rate of inflation often used in India. The WPI is available for all commodities' and for major groups, sub-groups and individual commodities. The basic advantage of this measure of inflation is its availability at high frequency, i.e. on weekly basis with a gap of about two weeks, thereby enabling continuous monitoring of the price situation for policy purposes. This index does not cover non-commodity producing sectors viz. services and non-tradable commodities.
The important measure at the point of consumption is the consumer price index for industrial workers (CPI-IW), which is meant to reflect the cost of living conditions and is computed on the basis of the changes in the level of retail prices of selected goods and services on which a homogeneous group of consumers spend the major part of their income. Its coverage is broader than the other indices of CPI like the CPI for agricultural laborers (AL) and the CPI for urban non-manual employees (UNME). Besides, CPI-AL and CPI-UNME are not considered as robust national inflation measures because they are designed for specific groups of population with the main purpose of measuring the impact of price rise on rural and urban poverty.
The national income deflator, on the other hand, is a comprehensive measure but statistically derived from national accounts data released by the Central Statistical Organization (CSO) as a ratio of GDP at current prices to GDP at constant prices. Since it encompasses the entire spectrum of economic activities including services, the scope and coverage of national income deflator is wider than any other measure. At present, the GDP deflator is available only annually with a long lag of over one year and hence has very limited use for the conduct of policy.
WPI is a headline measure appears justifiable on grounds of convenience as well as analytical reasoning. First, the WPI with a weekly frequency has just a two weeks lag as against the monthly frequency of CPI-IW with a lag of two months. Secondly, the commodity coverage in WPI is wider than that in CPI. Thirdly, WPI is computed on all-India basis whereas CPI is just constructed for specific centers and then aggregated to get the all-India index. Because of this feature WPI is more easily understood by majority of public.
The WPI comprises of three major indices-`primary articles", "fuel, power, light and lubricants" and "manufactured products". Any increase in these three is reflected in a rise or fall in the overall WPI. Inflation rate has been rising steadily since it touched 3 per cent on February 5, mainly on account of increase in administered prices in petroleum products and electricity. Annual rate of inflation shot up to a 73-week high of 6.31 per cent for the week ended May 6, compared to 5.96 per cent (p) in the previous week and 3.41 per cent a year ago. This was mainly due to a sharp increase in prices of some food articles and petroleum products.
The steady rise in the rate of increase in prices was reflected in consumer price index for industrial workers (CPI-IW) also with annual inflation based on this index rising to 4.83 per cent in March from 3.61 per cent in February. This fell to 5.51 percent in May this year 5.54 in April. The rate during May 1999 was 7.71 percent.
So why has inflation been going up and where is it headed? There are two main factors which affect inflation, one is interest rates and second is the value of the rupee. In India, there is a third very important factor also-the international price of oil. Economists state that in the last year of the past millennium, (1999-2000) international oil prices had hit their lowest, this coupled with the gradual southward movement of the interest rates, a steady rupee and comfortable liquidity had helped to keep inflation down. But then the rise in the administered prices and a rise in the freight rates started the inflation ball rolling in Feb-March 2000. Also from December onwards the international oil prices had started firming up and is currently at over $32/barrel. "And now with oil prices soaring and the interest rates inching up plus the fall of the rupee, the prices will spiral" says Professor Anil Sood, Faculty of Finance, Administrative Staff College, Hyderabad.
India has at present a flexible exchange rate regime. Now what happens when our exchange rate goes up, i.e.the rupee depreciates. "In this case our imports will get more expensive and will further push up the cost of production of goods and set the spiral of cost push inflation." Says Professor Paromita Das Gupta, Faculty of Economics-Administrative Staff College. Further, higher nominal rate of interest consequent upon higher inflation will raise the cost of capital thus rendering domestic industry less competitive. The competitive cost of capital and stable exchange rate necessitates that domestic inflation must align with global inflation. If you put India on this perspective, an inflation rate of 7 to 8 percent will be substantially high given the very low inflation rate, particularly in the developed part of the world which ranges from between 1%-3%.
The real interest rate is normally calculated by deducting the inflation rate from the nominal interest rate in the economy. Typically, the interest rate taken for this purpose is the Long term treasury paper. The equivalent in India could be the interest rate on long term Government paper which is about 11.8%. Thus the real interest rate in India could be about 4.8% at present taking an average inflation of 6%. This is seen as being relatively too high. The Indian industry prefers interest rates to come down gradually to 8-9%. And as it is competing on various global benchmarks, its input costs too have to approximate global levels. But with interest rates near zero levels in Japan and between 6-7% elsewhere in the US, it will be difficult for the Indian firms to be very competitive. But interest rates instead of coming down are showing a firm trend and have infact with the latest RBI measures, moved up. This means that the cost of goods produced will be more expensive and thus end products more expensive, thereby further fuelling the inflation rate. Finally with the prices of oil crossing the $32 barrel mark, a hike in petroleum products in India is now eminent. This will also add to the inflationary furnace.
The government role in controlling inflation can be enacted through maintenance of a stable rupee value and control over its own fiscal deficit. In the coming months, fiscal inflation will go up to about 7%-8%, and then depending on the oil prices and fiscal deficit, should gradually come down.
Aru Srivastava