Inflation: sources and policy options

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Friday , May 09, 2008 at 2220 hrs Wholesale Price Index (WPI) inflation has been rising almost continuously on a point-to-point basis since October 2007. It stood at 7.57 % in the week ending April 19, 2008. This is a provisional figure. If past trends are any indication, the final figure could be closer to 8%. CPI (rural), which has greater weightage for food, is running roughly 1.5% above WPI.

The rise in the rate of inflation is a combination of the base effect, global inflation in commodities and oil, and excess money supply. The WPI inched up very slowly from 208.8 to 211.9 between end-October 2006 and mid-June 2007. This has had the effect of magnifying the inflation rate during the corresponding period of the subsequent year, since the rate measures the increase in the index relative to the same time in the previous year. Consequently, after bottoming out at 3.07% in mid October 2007, inflation has continued to climb, crossing 7% in April 2008. Even if the WPI index were not to rise at all from its present level, inflation is likely to remain above 7% till end-June, and above 6.5% till August 2008, simply on account of the base effect.

Global inflation rates are also rising, especially in food, fuel and commodities. In the ultimate analysis, the spurt in food prices is attributable to the sharp increase in oil prices, leading to increasing diversion of foodgrain and edible oil to produce ethanol and biodiesel, and pushing up production costs. The Economist commodity index increased by 29% over the past year (as of April 29, 2008). Food commodities rose by 61 % and oil by 80%. The falling dollar has also contributed to rising global inflation, since international trade is mostly priced in US dollars. India is now much more integrated globally, with low tariff barriers and fast rising trade/GDP ratio. By virtually pegging its currency to the falling dollar, India is also importing the associated inflation.

Over the past year ending April 19, 2008, food articles and products, minerals and mineral oils, iron ore, iron and steel account for two-thirds of WPI inflation in India. Oilseeds and oil cakes, mineral oils, iron ore, iron and steel, with a combined weight of just 15% in the WPI index, alone account for 57% of the increase.