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Economy Nov 18, 2011

Why inflation is looking like a lost cause even in 2012

By R Jagannathan

It is simply too soon to celebrate.

Food inflation may have eased marginally this week (from 11.81 percent to 10.63 percent), and the monthly increase in the Consumer Price Index (CPI) has dropped from 1.25 percent in September to 0.97 percent in October. But Ajay Shah, professor at the National Institute of Public Finance and Policy, thinks the seasonally adjusted annual CPI rate is actually over 20 percent. And the wholesale price index for October is still at 9.73 percent.

Food price inflation is unlikely to moderate due to urban and rural income increases. Reuters

Even though our policymakers are hoping for a dip by December (primarily because the base of calculation from December 2010 is higher), the anti-inflation fight looks like a lost cause. Here's why.

First, there's the rupee. Since it is now clear that the Reserve Bank does not have the firepower to keep the rupee from depreciating at will, imported inflation is a reality. One third of our imports are oil - and unavoidable. Since we import more than we export, a falling rupee means we import more inflation.

Second, there's the fiscal-deficit-cum-energy-subsidy-driven push to inflation. The budget's fiscal deficit target of 4.6 percent of GDP has already been given up as an improbable one. The government is anyway borrowing Rs 53,000 crore more than budgeted - and if oil price increases are not passed on, the government's real fiscal deficit will bloat by another Rs 1,30,000 crore on the energy account alone. This will add to demand side pressures on prices. If oil price increases are passed on, inflation will anyway rise due to a push from costs. Either way, the economy's future inflation potential is high.

Three, commodity price inflation (especially in oil) isn't easing because the cheap money unleashed by loose monetary policies in the US, Japan and Europe is debasing those currencies and driving investors to hold real assets - including gold, oil and commodities. Real assets are less vulnerable to currency debauchery.

Four, food price inflation is unlikely to moderate due to urban and rural income increases. Of the two, the rural one is more important due to the inflation-indexing of wages in the Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGA). Reason: these rural spends are not being accompanied by increases in agricultural productivity. A good social sector scheme is being ruined by bad implementation.

Says Biswa Swarup Misra, Associate Professor at the Xavier Institute of Management, in a BusinessLine article: "Seen purely from an inflation management perspective, the indexation of MNREGA wages, without a corresponding increase in productivity, creates a wage-price spiral in the Indian economy."

Five, other energy prices are also going to rise. Apart from coal, power tariffs are set to rise steadily as our power distribution companies have huge accumulated losses running into thousands of crores. According to The Economic Times, power consumers should be prepared for 15-20 percent hikes in tariffs every year.

Add the costs of the Food Security Bill and other irresponsible social security schemes that the UPA is planning to unleash, and inflation is increasingly looking like a lost cause for now.

The only scenario is which inflation can come down is something worse: another global meltdown, and a sharper fall in India's growth story. That's not something to wish for.

by R Jagannathan

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