A fall to cheer about

Traditionally, manufactured goods8217; prices were responsible for India8217;s relatively high inflation rate. A protected manufacturing sector saw little need to offer competitive prices, and high prices there kept the inflation rate up.

What has happened now is essentially this. The manufacturing sector has been opened upconsiderably to foreign competition, the agriculture sector has not. Facing pressure from both domestic competition and imports, manufactured goods8217; prices have grown in the last three or four years at an annual average rate of just 3-4 per cent. Obviously, industry8217;s capacity toimpose high inflation rates on the country has weakened.

Agricultural prices simply have not stabilised in the same way at a lower rate of growth than in the past. The reasons are not hard to seek. The winds of liberalisation have yet to blow through India8217;s farms as they have done through its factories.

Agriculture has not been subject to the same competitive pressures on prices that industry has faced in recent years. Shortages in food supply have not been met through liberal imports, while severely controlled exports have not given farmers the benefit of better prices in bumper years. This has left food prices unstable, and has made them fluctuate from harvest to harvest, making them a much more active influence on theinflation rate.

Given this new-found influence, it is unsurprising that the 17-year inflation low coincides with a record 203 million tonne grain output. Doomsayers add that since low farm prices will not persist forever without agricultural trade being liberalised, predicting long-term low food prices is too sanguine, and so therefore is such low inflation.

The message is clear. Manufacturing prices, even with industrial recovery, could be on a long-term trajectory of low growth in a low-inflation world economy, because global integration has occurred in this sector.

This is nowhere near the case at present with agriculture. But, as Bibek Debroy of the Rajiv Gandhi Centre for Contemporary Studies says, 8220;the picture will change if we open up agriculture8221;.

The truth is that India has removed import curbs on large numbers of food items in recent trade policies. But the degree of import liberalisation will be determined by duty rates, not removal of physical restrictions.

Real farm-tradeliberalisation would mean greater overall integration with the global economy, more stable farm prices, and sustainable low inflation.Within manufacturing, Subir Gokarn of the National Council for Applied Economic Research points to an interesting dichotomy. Consumers have benefited hugely in cut-price deals in consumer durable purchases, where they interact directly with manufacturers. But the benefits of moderate prices are less apparent in other consumer goods.

This, he says, is because retailing has yet to see competition of the sort that manufacturers are facing. Retailers simply sell their goods at the maximum retail price rather than marking prices down to compete. But he predicts that retailing will see more competition in coming years, and there will be price benefits to be had here as well. How come, though, if the rate of price rise is down to a near two-decade low, buyers don8217;t quite feel the remarkable sense of price stability that a 3 or 2 per cent inflation rate suggests? The answer ofcourse is the well-known divergence between the wholesale price index WPI and the consumer price index CPI. The basket and weightage of goods in the WPI under revision, where the inflation rate just now is 1.8 per cent, is famously outdated. Currently calculated on the base year of 1981-82, the WPI gives a weightage to primary commodities of about 33 per cent, of which food consists of over half. In the CPI basket, the weightage to food is much more, so food price volatility is more sharply reflected in the CPI than in the WPI.

The CPI inflation rate of about 8 per cent is roughly 5 per cent higher than the WPI one. This is a much greater divergence between the WPI and CPI rates than the traditional 1.5-2 per cent. B.B. Bhattacharya of the Institute of Economic Growth says a more realistic WPI inflation rate, reflecting a proper consumption pattern, is 5-6 per cent, not the 2 per cent that is claimed.

And Sanjaya Baru of the Indian Council for Research on International Economic Relations saysinflation just now is so low because it was so high at this time last year. Between July and November last inflation was above 8 per cent for each of those months, because of food prices gone through the ceiling. Given that high base, the rate of growth of prices just now looks very low. Some call it a statistical illusion.

Last year8217;s price rise was chiefly due to agricultural shortages, fuelling a 20-per cent rise in consumer price inflation between April-February. Built on that base, and with a record harvest, inflation figures look decidedly cheery.

S.L. Rao, former director-general of the NCAER National Council for Applied Economic Research, says looking at inflation on a point-to-point basis comparing its rate this week to the same week last year 8212; is misleading. Even so, there is no denying the low inflation at present. Some predict a year-end WPI inflation of between 5-6 per cent on the strength of the bumper crop, subdued industrial demand and competitive pressures on industry, salaryincreases being confined to government servants, and low global prices, though oil prices have shot up in recent weeks.

Two factors are considered important by analysts. One is responsible monetary policy. Inflation this time is not being fuelled by the central bank increasing the money supply substantially to bridge the government8217;s deficit. Debroy warns though that a good deal of liquidity exists in the banking system, it is just not being released into the economy just at present. The other is that recent inflation has been due to food-supply problems, rather than by demand pressure.

But Rao for one suggests that precisely in the factors that make for low inflation now lie the seeds of future inflation. Manufacturing, which has driven the WPI down recently, is reviving. This argument is at odds with Gokarn8217;s view that manufacturing prices will not rise sharply even with an industrial upswing because of the pressures of competition. The rise of commercial credit will add to liquidity and inflationarypressures, he says.

Besides, while the government8217;s monetary policy comes in for some praise, the state of government finances is hardly happy. The fiscal deficit is out of control, and election spending could be about Rs 5,000-6,000 crore: about Rs 1,000 crore by government, the rest by political parties.

Kargil, even if does not go on for too long, will cost another Rs 5,000-6,000 crore. By September, Rao says, a strong spurt in prices is on the cards. He reckons that the full-year WPI inflation rate will be about 6-7 per cent and the CPI rate about 10 per cent.