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Inflation: Spectre Returns
In contrast to the last two years, the inflation we are now seeing is being driven by supply-side constraints and higher aggregate demand rather than by fuel prices and liquidity overhang on the account of large capital inflows. The rise in inflation in the first two weeks of January to 6 per cent and above, higher than the Reserve Bank of India’s stated band of 5 to 5.5 per cent, was led by primary articles and manufacturing.
In contrast to the last two years, the inflation we are now seeing is being driven by supply-side constraints and higher aggregate demand rather than by fuel prices and liquidity overhang on the account of large capital inflows. The rise in inflation in the first two weeks of January to 6 per cent and above, higher than the Reserve Bank of India’s stated band of 5 to 5.5 per cent, was led by primary articles and manufacturing. Food articles, particularly wheat, pulses, fruits and oilseeds, are now showing annual inflation rates of 8.5 per cent while manufacturing inflation stands at 5.6 per cent, due to more expensive edible oils, metals, cement and electrical machinery. Aggregate demand is being spurred by investments that show no sign of abating, by high capital goods production and by credit growth that has been described by the central bank as being “excessive”. On the supply side, the inability of foodgrain and oilseed production to keep up with rising demand has contributed as much to the price rise as hardening global commodity prices.
In response to the rise in inflation, the government has slashed custom duties on capital goods, project imports, chemicals, steel, cement and edible oils and banned futures trading in urad and tur. The duty-free import of wheat, pulses and sugar continues from last year along with the ban on exports. Some of these measures are expected to provide short-term relief; wheat futures are ruling at lower levels while maize imports are expected to cool domestic prices; the ban on urad and tur seem to be more in the nature of preventing speculative price rises. The duty cut on capital goods may not yield much, as most manufacturers are already paying lower duty through the Export Promotion Capital Goods scheme; steel prices are expected to harden further in March due to high demand while domestic portland cement prices are already lower than international prices. On edible oils, the impact has been mixed though the high demand and alternative uses of palm oil are making prices sticky.
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