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Inflation is a curse that gnaws at a nation's entrails, causing a major jolt toits economy. Indians watched with horror as the country's inflation touched 11.42 per centfor the week ending June 14, mainly because of the rising prices of food articles and vegetables.
As common peoplegrope for means to counter the ever-increasing prices of essential commodities, economists and financial analysts fear that the recent hike in fuel prices would soon pushinflation up further.
Siddhartha Roy, economic advisor to the Tata Group, shared his thoughts on the vexing issue of inflation in an interview with A Ganesh Nadar.
Roy has a Master's degree in Economics and a doctorate from IIM, Ahmedabad. He joined the Tata Group in 2003. He has 28 years of experience in research and in-house consultancy in macro- and micro-econometric modelling, strategic planning, country/firm competitiveness studies, pricing research and new opportunities identification.
He is on the experts committee of the leading Indian chambers of commerce. Excerpts of the interview:
In India, inflation is calculated on the basis of the Wholesale Price Index. In most other countries, it is calculated using the Consumer Price Index. Which is a better indicator?
There is no better or worse indicator. It depends on what you are looking at. If you are looking at how inflation affects the common man, you use the Consumer Price Index.
If you are looking at the entire economy, you use the Wholesale Price Index.
In the early nineties, there was double-digit inflation caused by supply-demand anomaly. Now they blame global factors. Is this true?
The economy today is more open than what it was in the nineties. As a result, imported inflation is unavoidable.
Moreover, the landed price of imports sets the threshold for domestic prices. Also, a part of the inflation is caused by the rising oil prices, which can be countered to some extent by redesigning the tax structure.
As an open economy, we have to allow exports.
Right now, a lot of agricultural products are banned from export. By that we deny the farmer a higher price. In an open economy, there has to be connectivity between local and global prices.
Is the fall of the dollar the cause of this inflation? If yes, the Reserve Bank of India can deal with that. Isn't it?
It's not that simple. If the rupee is maintained at a higher level, imports will be cheaper.
However, when the inflation rate goes up, there is a tendency to check the liquidity. And when you do that, the interest rates go up.
If there is a difference in domestic interest rates and international interest rates, that differenceleads to an inflow of foreign currency into the country therebyincreasing liquidity and inflation once again.
Thus, we have to adjust to various factors.
Economists believe that excessive liquidity caused by undervaluation of various currencies and fear of the collapseof the dollar lead to increased purchase of various commodities. This needs to be tackled upfront if inflation is to be controlled globally -- is this the macro economic truth?
If you look at the international scenario, it is true that money is invested in various commodities. The price increase in these commodities cannot be different from the under lying factors.
Let's take the example of gold. India is a major consumer of gold. The demand for gold in the first quarter has dropped as compared to the demand in 2007.
However, when oil prices go up and there is turbulence in the international economy people move to gold. But that cannot be divergent from other underlying factors. The basic supply demand will always affect prices.
Undervaluing of currency is unlikely to help. That only helps your exports. That cannot be an answer for all your problems.
Some blame it on the rise of crude oil prices, otherson the high taxes on crude oil. Which is correct?
At the current international prices, the actual cost of petrol should not be more than Rs 25 per litre. The rest is taxes.
What we have to strive for is to reduce the fiscal gap. A large part of our taxes is collected from petrol and diesel. If these taxes are reduced drastically, the fiscal gap will increase. That will also have an inflationary impact.
I would rather have a combination of direct charge on the item along with some tax adjustment.
The 5th Pay Commission raised salaries to exorbitant levels. The 6th Pay Commission will increase it even more. This will lead to more inflation. Should we put a freeze on salaries?
Salaries are a factor of production and it will find its market price. The private sector has its own scale of salaries. The government will have to pay more to attract the best talent.
The real issue is how to increase the efficiency of the employees so that the productivity of the economy goes up. Freezing of salaries will not help, increasing productivity will.
Trading in food futures: is this a major cause for price hike? What are the sums involved?
Futures allow you to discover the price. If the farmer wants to sell his products he can decide when he should
He will have some indicator. Our farmers are not directly linked to the futures market. The benefits of the future markets, therefore, are enjoyed by the intermediates and not the farmers.
The idea is not to kill the futures market but to keep it active and bring it directly to the knowledge of the farmers. The farmer should have the information and that will help him get the best price.
When you see the whole economy and then compare the futures market, it's a miniscule part and cannot actually drive prices up or bring it down. At best, it can just be an indicator.
Does the tightening of cash flow help control inflation as in India given that the parallel economy is as strong or maybe even more than the real economy?
At the end of the day, whichever economy you belong to, you are dealing with demand and supply. Cash reserve ratio is helpful when you don't want to raise the rate of interest. But when you raise the CRR beyond a certain stage, the rate of interest is bound to go up.
You have to do a balancing act and make sure that does not happen. I have already explained to you what happens when domestic interest rates are higher than international rates.
When you reduce money supply, hike interest rates to control inflation, does that choke growth? If so, then what's the solution?
When you raise interest rates, the small and medium scale industries find it difficult to go about their expansion plans or even carry on their day-to-day business. This is because they borrow from the domestic market only.
The large corporates have the facilities to opt for offshore borrowings and also to raise funds from the market. The focus for them shifts from the domestic market to the international market.
When they opt for offshore borrowings, the corporates have to consider the future exchange rate because that will indicate the real cost of one's borrowing.
As for choking growth, it affects the small and medium industry only. The larger ones will be affected but they have other avenues.
Inflation up to 5 per cent does not do any damage. Beyond that, it becomes a problem.
Higher prices mean better returns for our farmers but that also means higher prices for their inputs -- that leads to more inflation. What is the solution?
Fertiliser prices do not go up because they are controlled by the government. However, the administration of subsidy creates distortions from the supply side. If and when prices of foodgrains go up, the farmers benefit.
Will producing more agricultural and industrial products be a solution?
Increasing supply always brings down prices.
Liberalisation has led to a global lifestyle. It has also led to global inflation. Is inflation the price we pay for liberalisation?
You cannot say that. When we first started liberalisation, global prices were less than our domestic prices.
Our industry went through an upheaval and it had to become more competitive to survive.
Now global prices are higher and so we are facing a price rise too. Therefore, we cannot say that inflation is the price we pay. We have also benefited by it.
How does fiscal deficit affect the economy?
When fiscal deficit goes up, we need to finance the fiscal deficit. One has to go for additional money creation which is inflationary or one needs to go for better expenditure planning.
We are happy with an increase in foreign exchange reserves. But that causes inflation. . .
The question is how much foreign exchange do we need. We need a foreign exchange reserve to last us at least six to seven months. Funds' inflows continue and if we do not find a way to utilize them, that leads to inflation.
If we sign the civilian nuclear deal with the United States, we will have an alternate source of cheap power. We will become less dependent on oil, will that curb inflation?
If the power cost comes down, all the industries will benefit.
Is controlling prices interfering with free market? Is it a sign of anti-liberalisation?
Controlling prices leads to re-allocation of resources.
If you control the price of cement, who will invest in the cement industry? Cement industry will then start looking for avenues where there is no price control. We need infrastructure. We need cement. We have to encourage capacity creation of cement. Else, instead of cement, manufacturers will produce soap.
What measures would you suggest to control inflation in India?
I think what is really important is the perception of inflation. That is not determined by the rates we see in terms of Wholesale Price Index.
It is what the consumer feels at the market level. It also creates expectations about future inflation and a clamour for higher wages. When the price of a vada pav goes up from Rs 5 to Rs 6.50, that hurts. When the prices of edible oil and rice go up, that hurts.
With the onset of timely monsoons this year, the kharif crop is expected to be good. This will help bring down prices.
If you ask me, I would focus only on food prices. Once food prices come down, the perception of inflation will come down as well. The common man is not really concerned about the price of cement or steel or crude oil, for that matter.