Inflation is a very important tool to gauge a nation’s growth. Quite often it is argued that inflation is a root cause of all evil but it is primarily a very powerful monetary tool. S S Bhandare, Economic Advisor, Tata Economic Services expresses his views to Jayashree Jakhade of Financial Express, Thinktank. Excerpts:Which is a better indicator of inflation WPI or CPI?
Both WPI and CPI have been used quite extensively to measure inflation in India. However, it is difficult to state conclusively which one of these is a better indicator of inflation. In fact, there is yet another measure of inflation, that is, national income deflator, which is rarely being used. Having said this, let us recognise some critical distinguishing features of these two divergent sets of inflation indicators:
WPI indicates price changes either inflation or deflation at the stage of wholesale market, CPI measures the same at the retail end of the market. Coverage of commodities and their respective weightages are significantly different in both the sets of indices.Raw materials and intermediate goods do not reflect in CPI .It is dominated by the food groups commanding 57% of the total weightage. While in the case of WPI, the weightage for primary articles (which includes food items) is just about 22% in the new series (1993-94 = 100). Likewise, WPI does not take into consideration the entire services sector, while CPI at least recognises the relevance of housing (that is, rent) and transportation in its calculation.CPI,calculates indices for different sections of society.
WPI series is available weekly whereas CPI data is on a monthly basis.YOY variations exist in both indices. But over long run there is a close coverage. Over last five decades (1950-51-1998-99), the annual inflation rate on WPI works out to around 6.5% while moderately higher at about 6.9% on CPI.
If worldover CPI is used, then why is it in India that so much of importance is given to WPI making India's inflation rate incomparable with the world?
CPI is more preferred worldover. But it must also be stated that many countries formulate indices of producer prices, which come very close to our WPI. In the long run there would be no problem.
Is there a direct relationship between money supply and inflation? If yes, then how is that in India when money supply rises inflation falls?
The cause and effect relationship between money supply (M3) and inflation has been a matter of extensive and acrimonious debate for many years. In the Indian context, empirical analysis does establish a strong casual relationship among M3, real output and prices over a long-term basis. Thus, the gap between the rate of expansion of money supply and real output (GDP) eventually finds its reflection in inflation. Taking the long-term trends of about three decades (say from 1970-71 to 1998-99), it has been observed that while the annual real GDP growth rate was around 4.8%, M3 growth during the same period was over 17%, resulting in an inflation gap of roughly over 12%. During this period, the rate of inflation averaged at around 8.5% per annum. I t is true that this is not the exact representation of the inflationary gap.
In recent years, however, the cause and effect relationship between M3 growth and inflation rate appears to have weakened substantially due to:
Structural changes in the economy
Impact of globalisation
Intense competition in the wake of surplus capacityConsequently, even with high M3 growth,we are experiencing a declining inflation rate. In 1999-2000, however, M3 growth slowed down to about 14% accompanied by a 2.9% rise in WPI and real GDP growth of 5.9%.
Why is it that during the times of election or budget announcement that inflation is normally low?
It is not true that in times of elections or budget announcement, inflation is usually low. However, management of price situation invariably has political connotations. High level of inflation has never been found conducive for a party in power while seeking the support of the electorate. Likewise, the political motivation is also to influence the central banking institution (in our case the RBI) for pushing through a tough credit policy for reining in inflation. This, no doubt, can provide a short-term reprieve, but eventually macro fundamentals of the economy come to govern the behaviour of markets and the price situation.
Is inflation in your opinion calculated accurately or is it manipulated to reduce government financial pressures for higher DA, etc.?
It will be incorrect to suggest that in India there have been a serious manipulation of inflation rate with a view to reducing the consequential pressures on government finances either through increased DA payments or increased allocations for subsidies and other commitments. There are bound to be some deficiencies and anomalies in the compilation of various indices of the inflation rate. Thus, the series should be revised at least once in 10 years.Is inflation a growth indicator, that is, if low inflation depressed growth and if high inflation rapid growth?The relevant issue is not to confuse high or low inflation as a reflection of high or low growth rates. There are economies that have scored high growth rates even in the wake of low inflation and vice-versa. China's persistent high growth performance (over 9% real GDP growth) was accompanied by a double-digit inflation rate which has slightly decelerated its growth performance.
On the other hand the US is currently enjoying relatively high growth rates (3.5 -4%) in the real GDP in the midst of low inflation of just around 2 %.In contrast, Japan’s sluggish economic performance is symbolic of deflation.
In the Indian context, what is desirable of course, is high growth of around 7-8% in real GDP accompanied by moderate inflation of not more than 5-6% per annum. This relatively high inflation is inevitable in India as we have still to overcome many structural rigidities involving drastic reduction in both explicit and implicit subsidies and the consequential raising of prices or user charges of various public utilities.
With the government cutting down on its expenditure by reducing subsidies and adopting harsh monetary measures will inflation come down?
As such there is no substantive effort to cut down the government expenditure, although, from time to time, some modest initiatives are taken in reducing subsidies (included in the latest Budget). In the medium to long-term, more effective expenditure control and management should become an integral part of India’s new development strategy. Having said this, in the first round, reduction of subsidies does create upward pressures on prices. What is critical is the reduction in fiscal deficit, particularly, the revenue deficit to deal with the Indian price situation.
After remaining stable for a couple of weeks around 3-3.5 per cent, inflation is now on the rise taking into account diesel, petrol and LPG price hikes, where will this level settle at?
As a matter of fact, the inflation rate in India has been consistently falling for a fairly long time till it touched the low of 2.4% on a Y-o-Y basis by mid February 2000. Given the fact that this is a lean season, there is going to be some upward pressure on prices and we would see inflation moving surely in the 6 to 6.5% range on a Y-o-Y basis.
Even so, there is no threat of inflation crossing this tolerable level, unless, of course, the agricultural sector suffers a sharp setback by the accentuation of the drought during the ensuing monsoon season. However, what is of significance is the fact that India is favourably placed in terms of its supply management thanks to the huge stocks of food and comfortable forex reserves. More importantly, as in the advance countries of the world, there is an emergence of a -- new paradigm -- , wherein inflation control is driven by the market forces buttressed by the benefits of new technology and increased competition boosting productivity growth.
What is the right level of inflation that India can digest if it has to attain an eight per cent GDP growth?
There is an inevitable trade-off between inflation and growth; for achieving high growth rates, it becomes imperative to sacrifice relative price stability. This trade-off is based on historical experience. However, as mentioned by Dr Meghnad Desai in one of his speeches, -- there is a basic inflation-aversion of the Indian society --. Thus, whenever there are phases of high inflation, a strong resistance is built through the political process, which translates itself into strong policy frame.
We believe that to achieve a 8% real GDP growth on a sustained basis, Indian tolerance limit to inflation will be about 5-6% per annum. But to minimise the adverse implications of such high inflation on the vulnerable sections of society, it is necessary to see that the gains of high growth are equitably shared with the people below the poverty line.
With the revamped inflation index will it help give us a more realistic picture of the actual level prevailing in the economy?
The revised WPI series with 1993-94 as the base is certainly an improvement over the previous series, which had the base year of 1981-82. Undoubtedly, a major transformation of the economy in the post-reforms period has resulted in the old series getting out of tune with the new realities of the economic situation. No index series, of course, can be perfect. There will always be scope for further improvement, keeping in view the changing structure of relative importance of different commodities in the economy. In the ultimate analysis, in any computation of indices, whether of prices or production, what is of importance is the quality of data.
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