Column: Tackling inflation politically

Written by Meghnad Desai | Updated: May 26 2014, 09:50am hrs
Everyone has agreed that the new governments number one priority is bringing down the rate of inflation. There is a standard confusion in popular parlance about the level of prices and the rate of inflation. The demand is always for bringing down prices. Even Edward Heath, when he won the British election in 1970, was excoriated for failing to cut prices at a stroke. He had only promised to cut the rate of inflation at a stroke. Again we hear that Modi should bring prices down. Perhaps, but for a start, he should bring down the rate of inflation.

There are people in the BJP who believe that Raghuram Rajan is choking off investment by using the rate of interest as an anti-inflation weapon. But a central banker has no other weapon; he has to play golf with one club. His predecessor RBI Governor had made it clear that he sees the inflation as a result of excess demand as indicated by the budget deficit. Bring down the deficit, he more or less explicitly said, and I will cut interest rates. The budget deficit has not been brought down whatever P Chidambarams window-dressing may say. The incoming FM will have to seize the bull by the horn, reveal the true numbers and make drastic cuts in expenditure for the remainder of FY15.

Of course, as Alfred Marshall said long ago, prices are determined by the two blades of a pair of scissorsdemand and supply. The incoming PM has thought about the supply-side and had prepared a note for the last PM way back in 2011. There were measures to remove structural rigidities, improve marketing, warehousing, transport networks and release stocks of foodgrains in time. All that can be implemented. But the time-frame for the removal of rigidities to have an impact on the rate of inflation is long and variable, as Milton Friedman said about the effect of money supply on inflation.

Politically, the prices that matter are those that people encounter in their daily purchases. Economists have to learn from marketing experts and model repeat-purchasing, i.e. purchasing behaviour on the lines of frequencydaily, weekly, monthly purchasesand then the opportunistic buying as and when the time is ripe. It is vegetables which are bought dailyonions especiallywhich make the headlines and spell trouble. This has been known for some time and yet the UPA-2 failed to take precautionary measures to guard against onion-price-rise. It is not rocket science to model daily purchasing behaviour as well as the onion market supplies and demands on a daily or weekly basis. If rains fail in July in Nasik, there would be price rise in the onion market by September. The private traders know this and begin stockpiling as soon as the rains fail. Why does the agriculture ministry not know this and start its own stockpile

Now that the new government will have a full-time minister for agriculture, unlike in the UPA in the last 10 years, these tasks should be urgently addressed. Daily price rises are such that consumers cannot substitute easily one product for another or postpone purchases till prices come down. They feel compelled to pay the higher price as they encounter the price daily. This is why vegetable and, for the better-off sections, fruit prices have such a huge political charge.

RBI should put resources into the construction of a high frequency weekly price index for daily purchased goods. This will signal the pressures in the market which eventually feed into the more traditionally used price indices which are published at a lower frequencymonthly or quarterly. This weekly price index can then be a barometer that indicates the level of short-run pressure in the market, an early warning signal. After all, consumers notice this and daily newspapers reflect their concerns. It is time economists caught up with what real-life consumers notice.

That said, the longer-run argument for removing structural rigidities is strong and action is overdue. The anti-market logic which has prevailed in India for the last 70 years puts up barriers in the movement of goods across regional and local area boundaries. This is supposed to control prices but does nothing of the kind. The prejudice goes back to pre-modern times when famines used to occur but even then grain could not move from the surplus regions to the deficit ones as such movement were hindered by tolls and prohibitions. It was in that context that some merchants in France said to Colbert, the finance minister in the mid-18th century, Laissez nous passez; laissez nous faire (Let us pass; let us do as we want to). Thus was born laissez-faire and the modern market economy. It is time India caught up with pre-Revolutionary France.

The author is a prominent economist and Labour peer