Why inflation won’t come down & will remain stickily high

Policy makers are either in a state of denial or are engaging in wishful thinking on inflation.

The noises emanating from the finance minister to the economic advisor is that inflation in expected to fall from current levels of 7.5%.

The 7.5% inflation number is the reading of the wholesale price index (WPI) for the month of November.

The government expects inflation to fall on the back of inflation-control measures adopted by the government and the Reserve Bank of India (RBI) as well as on the back of lower food prices post a normal monsoon.

The government has one inflation control measure, increase subsidies. Too bad if it shows up in the fiscal gap and actually ends up fuelling more inflation.

The freeing of petrol has been one reformist inflation control move but diesel prices are subsidised leading to a red hot auto market where vehicle sales are hitting the roof.

The government is committed to subsidising diesel prices and is willing to take on the additional fiscal burden due to rising oil prices.

Oil prices, which were behaving well till a couple of months ago have touched two-year highs of $90 per barrel.

Countries like China and India which are subsidising fuel is not helping curb consumption leading to rising fuel prices.

The government is also committed to keeping its employees happy by paying them higher salaries as well as compensating them for the higher inflation through increased dearness allowance.

The government hoped food prices would have come off on better monsoons. Unfortunately that has not happened with food inflation threatening to trend much higher from current levels of 10.75% on the back of rising prices of vegetables.

Food inflation has got nothing to do with good monsoons. The fact is that cost of  agriculture labour has gone up due to the government’s Nrega program where employment is guaranteed at a minimum wage whether the employment is productive or not.

The overall inflation is also hitting distribution costs of food articles and this is not likely to go down given an upward trend in inflation.

The government is contemplating higher minimum support price or MSP for crops for higher supply but that by itself is inflationary in nature as higher income at the farmers hand increases demand but the ineffective distribution system of the government hampers lowering the  price of foodgrains to the end user.

The government’s inflation control efforts are inflationary in nature and leads to more pressure on the fiscal deficit as well.

The RBI, on the other hand, has been steadily raising policy rates while keeping liquidity tight in the system to combat inflation. This should ideally bring down end demand as loans get costlier.

The RBI however also has a growth commitment to keep (to themselves or to the government?) and they are buying government bonds to reduce liquidity pressures.

The return of double-digit food inflation, Page 12