Deepak Mohanty tries to unravel this puzzle.
I take this opportunity to share my thoughts on the topic of inflation which affects one and all. Over the last three years the persistence of inflation in an environment of falling economic growth has come out as a “puzzle”. In my presentation I propose to address the following questions: What do I mean by a “puzzle”? Why do we need to worry about inflation? What is the nature of the current inflation process? How did monetary policy respond to the recent bout of inflation? I conclude with some thoughts on the way forward to achieve price stability.
He cites several factors for inflation persistence despite growth slipping:
The high inflation during 2010 and 2011 was a combination of both adverse global and domestic factors as well as supply and demand factors.
First, crude oil and other global commodity price trends as well as exchange rate movements are increasingly playing an important role in defining domestic prices. Moreover, the Rupee depreciated from an average of 45.7 per US dollar in 2010 to 46.7 in 2011. The depreciation of the Rupee was particularly sharp in 2012 as the Rupee averaged 53.4 per US dollar. Empirical evidence suggests that one percentage point change in the Rupee-dollar exchange rate has 10 basis points impact on inflation.
Second, while the growth in domestic agricultural production has stagnated around 3 per cent per annum, the demand for food has increased. Although the country currently has sufficient foodgrains stocks, it is not yet self-sufficient in pulses and oilseeds.
Further, with the increase in income, real consumption expenditure has grown significantly. Recently released key results of the NSSO 68th round survey (2011-12) on household consumption expenditure indicate that real per capita consumption expenditure in rural areas increased at an average rate of 8.7 per cent during 2009-12 as compared with 1.4 per cent during 2004-09. Similarly, urban real per capita consumption increased by 6.7 per cent as against 2.4 per cent in the corresponding period. The fact that real consumption expenditure expanded during a period of high food inflation indicates that the demand remains strong, feeding into higher price levels as supply elasticities remain low.
Third, with the persistence of near double-digit inflation in 2010 and 2011, the medium- to long-term inflation expectations in the economy have risen, underscoring the role of higher food prices in expectations formation. If inflation is expected to be persistently high, workers bargain for higher nominal wages to protect their real income.
Fourth, there has also been added stimulus from the crisis driven fiscal and monetary policy. Fiscal consolidation process was reversed in 2008-09 which impacted the macroeconomic conditions (Chart 2). Higher fiscal expansion also impedes efficacy of monetary policy transmission.
Again tells you how unprepared we have been for India’s so-called growth engine…I don’t know why our policymakers are so sanguine about our inflation prospects…
Deepak Mohanty says in the beginning India has always been a lower inflation country amidst several developing and emerging economies. And one expects this to continue. Well, we also had low growth then (called Hindu rate of growth) and incomes hardly rose as they have in recent times. The recent experience is pretty different with high inflation followed as soon as growth inches up. Growth moved up in 2003-08 but inflation did not as times were good. It was a global issue where inflation remained low which also blinded the policymakers who ignored building financial instability. The commodity prices were low and so were oil prices as well. And as soon as they moved up in 2007-08, our inflation moved up as well.
Now times are very different. In a supply starved economy full of corruption, we are going to find it tough. We have discovered ways to boost growth but hardly any to tame inflation. The only way to tame inflation unfortunately has been to lower growth…