The misnomer of low inflation

Low inflation numbers in recent times are being presented as a paradigm shift that sets the stage for a new phase in the Indian economy. As the Economic Survey (Vol. II) released this month put it, the last four decades have broadly seen four phases in inflation trajectory. Beginning 1977, as many as 23 years gave us nine per cent inflation, followed by low inflation of four to five per cent from 2000 to 2005, and then a resurgence of inflation back to nine per cent from 2006 to 2014. And now, here is a fourth that offers the idea of “a new phase of relatively low, possibly very low, inflation”.

The retail inflation rate measured in terms of Consumer Price Index, or CPI, plunged to its lowest level in the series at 1.5 per cent in June 2017. Though the July inflation rate showed an increase, it was still at a low level of about 2.4 per cent. This is in marked contrast to the peak headline inflation of 11.51 per cent and food inflation rate of 16.65 per cent witnessed in November 2013. Moreover, beginning fiscal 2012 till August 2014, there was persistence of high inflation and during most of the period, the nation suffered a double digit inflation rate. Thus, the trend is along a “disinflationary glide path”, a smooth climb down to the lower reaches from which the government believes the beast is unlikely to rise in a hurry.

How correct is this picture? And how does it square with what the average householder faces when she goes to, say, the vegetable market or the provision store?

Any check at the market will quickly reveal that the ordinary consumer is unlikely to believe that prices are down. With tomatoes at Rs.80, onions at Rs.40 and potatoes at Rs.25 per kilo each now, the pressure on the ordinary citizens’ wallet is unchanged from the time when the CPI inflation numbers told a different story.  In fact, the RBI’s monetary policy assessment of Aug.2 captured it well by noting that households have completely discounted the low inflation prints, an argument also recorded in the statements of one of the RBI Executive Directors as part of the minutes of the same meeting.

It is true that the aggregate CPI number will not reflect all products and services, nor will it give equal weightage to prices recorded in different geographical locations. Price levels in States with higher consumption relative to the national total will be reflected more in the overall number than in States with lower consumption spends.

So while actual experience and perception will and often does vary from the published number, what is important is that this time, the phenomenon is being seen as “a structural disinflationary shift driven by more permanent developments in both the international oil market and domestic agriculture…,” as the Survey sees it.

Geopolitical developments and oil prices apart, the story of Indian agriculture showing stability because of new minimum support price frameworks and liberalised marketing under the new government might suggest that the agri sector never had deeper issues and that tweaks from the top were all that were needed. Data shows that volatility of output growth in Indian agriculture has declined not now but since 2003. Yet, episodes of high food inflation are only too recent to be forgotten.

So, in sum, the numbers look good on paper but their presentation and reading suggests a rush to conclude that a period of low inflation witnessed now is a trend and a theme rather than an event. It is an enthusiastic and partisan embrace of one version of the real story. In doing so, it ignores some basics of policy making, which were well elucidated by the former Governor Dr. Raghuram Rajan when he noted in July 2016: “Interestingly, the clamour builds up whenever year-on-year inflation is low relative to the policy rate, no matter whether low year-on-year inflation is because of mechanical base effects, and regardless of whether inflation is projected to go up in the future. No serious central bank determines policy on such a basis...”

It is not inflation control per se which is important but the anchoring of inflation expectations when it comes to public policy in general and monetary policy in particular. It is pertinent to note that inflation expectation is currently at a high level. The inflation expectation is mostly based on the market behaviour of prices.  According to the RBI household inflation expectation survey, households’ inflation expectations three months ahead and a year ahead have gone up. More importantly, more than 70 per cent of respondents expect prices to rise. Since inflation expectations are an important determinant of actual inflation, the survey points to the risk of higher inflation in the days ahead.

Therefore, a more reasonable view of the reduction in the retail inflation is that it is a result not of some durable or structural changes but of a combination of factors like the collapse of international crude prices, the new CPI index, demonetisation and favourable supply shocks along with the statistical benefit of a high base rate. This would indicate that the statistical and non-structural factors have contributed more to the lower inflation rate.

Management of the inflation trend is more a process and the authorities, particularly the government, should refrain from celebrating it so soon. For the poorer sections, what is important is not the change in inflation rate but the prices which are ruling in the market. At the current level, prices of cereal, pulses, vegetables, animal proteins such as egg, meat and fish are beyond the reach of the poorer sections and even the middle class. The answer to managing lower inflation is not a statistical number like four per cent , two per cent and six .per cent.

What is needed is a concerted effort by the government both at the Central and State levels to increase supply through farm productivity by introducing improved technology and agriculture-friendly mechanisation. Authorities over the years have neglected agriculture and favoured services but the time has now come to prioritise agriculture and agriculturists.  Announcing that the war on inflation is over takes the nation away from this and related policy directions.

(R.K. Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIMR)