Monday, March 31, 2008

The most sensible comment on the present inflation scare

An editorial in Indian Express:

The sharp rise in wholesale price index based inflation to 6.68 per cent, no doubt, calls for a response from the government. A high level cabinet committee is to meet today to decide its response. It is important that the government analyse the causes of inflation before proposing a response. Last year too, about the same time, inflation had risen sharply. This was brought down by an increase in interest rates. But last year, inflation was demand driven and the rate hike helped in cooling down the overheated Indian economy. Growth slowed down, as expected, and price rise was contained. This year’s inflation is different. It is coming at a time when the economy is slowing down. The strategy to reduce inflation cannot be based on reducing growth further. This year’s inflation is primarily the result of a supply shock coming from rising world commodity, food and oil prices. It would be a mistake to raise interest rates to deal with this kind of inflation. Growth would slow down further and, given that inflation is due to higher global prices, it may not be significantly contained.

The best way to deal with international price inflation affecting the Indian economy would be a strong rupee. The exchange rate pass-through from a change in the rupee-dollar rate to domestic inflation is positive. In other words, when the rupee appreciates it reduces the price of imported goods or import parity priced goods, that is, goods whose prices are determined by world prices. This will help in pulling down prices. Instead of quantitative restrictions such as a ban on exports of food products whose world price is high, a strong rupee will ensure that it is less profitable to export these items. This will help make more food available domestically. Also, it will make it cheaper to import food and food products. The government should, in addition, eliminate import duties on edible oil, for example, to make it more affordable. The combination of a strong rupee and the removal of duty will make food products cheaper. It will also eliminate incentives to hoard.

One of the most serious policy mistakes made by the UPA government over the last year was to prevent the Indian consumer from benefiting from a strong rupee. The political power of exporters appears to have forced the government to resist rupee appreciation. Since rupee appreciation comes at the cost of higher domestic prices, today, the government is paying this price. Hopefully, now that we are closer to an election, the interest of the larger mass of the population may rule over the interest of a concentrated group of exporters.

4 comments:

  1. This might be true to some extent that a group of powerful exporters might have pressurizing the government to curb rupee appreciation.
    There is much fairer side attached to this rupee appreciation. IT/ITES and Textile are two most affected industries, both are labor intensive.
    IT has already taken measures by increasing the billing rates (as there was a good scope for the same) and by cutting the allowances of its employees. In some cases the Foreign per day allowances has cut down to the extent of 40%. The people with better skills are now refusing to go outside and work at these allowances. This will definitely hit more to the IT companies in the longer term. In my opinion they should now move up in the value chain. With software consulting they need to develop capabilities for business consulting. (e.g. A company giving ERP solution may also offer Business Risk Management as bundle product).
    The Textile is already in a bad shape, where the production is getting severely affected due to non-availability of Raw Material, as most of it is getting exported (after India entered into agreement with WTO). The price of finished good (Yarn for that matter) has not moved up following the increase in raw material price. This has happened due to cheaper imports of finished good. This can only be fought with the better technology and production at much reduced rates. Rupee appreciation will definitely benefit Textile sector for the short term even they come in the export category.

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  2. I was just wondering if the market is factoring the increased income due to revised income tax slabs and 6th pay commission to fuel the inflation…

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  3. we are now in the regime of higher food prices, not due to higher oil which is just a result of dollar weakness but the paradigm shift from aggregerian economy to large scale industrialization( or should i say ITlization)....the rate of population growth in an entropy of fixed land resource is multiplying the problem....we have to be in tht sytem n in future the situation will be much horrible...the upward mobility of the middle class will redefine the socio system n add new varibles in this problem ...
    Still there are plenty of nations (specifically Eastern Europe) just waiitng to emerge as new economic power ....so isnt it again add some more money and so inflation in this inflated world????if there is some weakness in near time for inflation it will be certainly for very few months...be prepare urself to pay more coz u r getting more or else pray for a depression like after 2nd world war...

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  4. There are two ways to deal with the rising commodity prices, either to increase the production or to reduce the duties on the commodities while importing the same. Since the government didn’t gave a damn about easing the supply side constraints for the past 4 years by encouraging the farmers, it has no other option but to reduce the duties on commodities. Regarding increasing the value of rupee, I don't think the government will do that since rupee has already appreciated beyond the comfort zone, here on if it increases the rupee it will have an adverse effect on the tax front, and many a industries in the export front have already lost their competitive advantage.

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