How to deal with the price surge

With rising crude prices, a tight global food situation and hardening commodity prices, it is no surprise that inflation is up. What was not expected, however, is the extent.

The sudden surge from 5 per cent to 7 per cent within a short span of a month has caught everyone -- the government, consumers and others -- offguard. A spurt in edible oil, steel and iron ore prices in quick succession has contributed to the current bout of inflation, which is anyway understated, as global crude prices have only partially been passed on to the Indian consumer.

The culprit in this latest bout of inflation as reported on March 22 was the delayed revision in the iron ore prices, something similar to what happened in June 2004 when the iron ore price index was revised by over 100 per cent within a week. The delay in updation was so significant then, that the resultant spike in inflation shocked everybody.

This time around as well, the sudden and sharp spike in inflation has created panic. The government has hurriedly announced a slew of measures to tame it. The 'surprise and shock element' in inflation and the reaction to control it raises two critical questions. The first relates to the adequacy of the inflation monitoring mechanism in India and the second to the efficacy of current inflation control measures.

An effective inflation monitoring mechanism needs to be in place

The entire globe is currently in the grip of food- and commodity-led inflationary spiral. The World Bank Group estimates that 33 countries around the world face potential social unrest because of the sharp rise in food and energy prices. Food shortage-related riots are already being reported from some countries. So far India has remained quite insulated from the surge in global prices (see table). 

RELATIVELY INSULATED                    (Figures in %)
	International Inflation*	Domestic Inflation#	Import Dependence
Rice	55.4	7.0	No
Wheat	117.6	0.9	Low
Maize	28.7	-2.8	No
Palmoil	84.2	NA	High
Sunflower Oil	159.4	16.5	Low
Soyabean Oil	89.6	3.5	High
Groundnut Oil	62.3	7.9	No
Rapeseed/Mustard	79.1	20.1	No
Steel	42.0	12.4	Low
* Jan-March, 2008 FAO                                    # Jan-March 22, 2008, WPI, GoI

Wheat and rice witnessed phenomenal inflation during January to March 2008 in the global markets. In comparison, domestic inflation in rice and wheat has merely been 7 and 0.9 per cent respectively, in the corresponding period. Between 2003-04 and 2007-8, the production of wheat increased at 0.9 per cent per annum which is below the population rate of growth. This has depleted the domestic buffer of wheat stocks. As a result, we are increasingly becoming dependent on imports.

If domestic production of wheat falters, expensive imports will put pressure on domestic inflation. The same is true of oilseeds. The recently announced purchase of wheat on 'call option' has been at a substantially higher price than what Indian farmers get for their produce.

Only in commodities in which we have import dependence, such as edible oils, has domestic inflation followed global trends. One exception appears to be soyabean oil where international prices have seen a sharp rise. The soyabean oil component of the WPI has, however, reported an increase of 5.6 per cent only in the week ending March 22, 2008.

The NCDEX data on soyabean oil prices shows a high inflation of 42 per cent during the same period. It appears that soyabean oil price in the WPI is yet to be revised. Clearly there are issues with the measurement and timely updation of WPI data. Until a comprehensive measure of inflation is ready, there should be a serious attempt to reduce time lags in the updation of WPI data. Otherwise, unexpected spurts in inflation will keep surprising us.

Efficacy of inflation control measures

To put a lid on prices, the government has announced a mix of fiscal- and trade-related measures. The duties on edible oils have been slashed and curbs on exports have been put in place. Steel companies are being persuaded to reduce prices.

These will have some moderating impact on inflation. The reality is that the moment India goes out to import, international prices too move up, more so given the tight global food supply situation. Further, the recent action by a number of countries to restrict exports has worsened the global food supply situation further.

Panic policy action from government authorities under such circumstances could lead to unwanted reaction. Initiatives like price control send negative signals. In the last few months, countries like China have also resorted to price controls on electricity, food and fertilisers. Do price controls really work? They are clearly more damaging to the medium-term stability in prices as they distort the allocation of resources and create shortages.

What about immediate relief from rising prices to the vulnerable groups and 'buying time' for more enduring measures to be put in place? It has been found that in the short run too, companies and traders often try to evade price ceilings by deteriorating the quality of goods. Price controls also encourage hoarding. This could imply that additional official machinery would need to be pressed into service to ensure quality standards and check hoarding. There could be some justification for price controls in an emergency situation such as war or famine. Such occasions are rare indeed.

The inflationary surge today is a result of global conditions as well as our prolonged neglect of agriculture. Given the high weight of food in our consumption basket, we ought to direct domestic policy towards raising productivity in agriculture to attain self sufficiency in food.

We might have to live with an unfavourable global food price scenario over the next few years as the global food crisis will take a while and a lot of concerted effort to sort itself out. Therefore, until self-sufficiency in food is achieved, targeted subsidies and food distribution need to be beefed up to protect the vulnerable sections of the society as and when the need arises. Despite its limitations, this would be more effective than price controls.

• Inflation, the silent killer!

The author is Director and Principal Economist, CRISIL Limited. The views are personal