Inflation on the rise – India

Inflation is the most hated word by all; more so by politicians seeking reelection in an election year. Here we are in the midst of preparatory year to elections. The ruling congress believed that it has swung the people to its side with its largesse (Rs. 600 Billion to Farmers, Rs. 400 Billion to tax payers) etc. Everything sounded fine, till the effects of mid February rise of petroleum products sunk in the economy. The whole sale price index registered a rise of 6.98% over the previous year. This has activated the left, principal supporter of the ruling coalition to lock horns with congress, largest coalition partner in ruling combine called UPA, accusing it of not taking enough measures to stem inflation.

When we look at the budget speech of Indian finance minister we have prophetic words:

“There are other downside risks too. World prices of crude oil, commodities and food grains have risen sharply in the period April 2007 to January 2008. The position of crude oil is well known to this House. Among commodities, the prices of iron ore, copper, lead, tin, urea etc are elevated. The prices of wheat and rice have increased in the world market by 88 per cent and 15 per cent, respectively. All these trends are inflationary, and there is pressure on domestic prices, especially on the prices of food articles. Consequently, the management of the supply side of food articles will be the most crucial task in the ensuing year.”

These words of wisdom were followed by the pat on the back for a bountiful year of agriculture.

“Let me first deal with agriculture, briefly for the present, and at some length later. The Ministry of Agriculture has estimated that the total output of food grains in 2007-08 will be 219.32 million tonnes and that will be an all time record. In particular, production of rice is estimated at 94.08 million tonnes; maize at 16.78 million tonnes; soya bean at 9.45 million tonnes; and cotton at 23.38 million bales (of 170 kg each) - and each of these will be an all time record.”

The news of inflation has not surprised many economists who are watching helplessly as the segment after segment of people were increasing their bargaining power in securing wages. When the salaries class and others had secured more and more paper money the demand for goods from them was unrelenting. The international crude prices were rising in the past year by more than 300% and for any economy not to experience a mismatch in demand & supply of various commodities will be difficult. Major inputs to the agriculture had risen following the crude price hike. Further the Indian economy is being increasing dominated by human capital led services industry. The last five years have seen increasing taxes and collection form services sector. Further the branding of goods and increasing share of organized retail in home budget have led to more price increase situations. The pricing of petroleum products in India is a vexed and unreformed issue. The recent budget has also not capped the state taxes which form more than 50% of the cost of petroleum products paid by the consumer. Therefore what we are seeing is the multiplier effect of uncontrolled rise in petroleum prices an essential input consumed by every one and in all stages of commodity consumption by population.

What are the options with the finance minister?

The high powered committee is meeting today to discuss methods to curb price rise.

The monetary options are perhaps pre-empted as we are witnessing a paradox of saving by earning population at 36% of GDP and yet there has been no slide in the interest rate. The credit growth is weaker. If the supply side of commodities and products needs to be increased it cannot be at a higher interest when every one including the finance bodies are unlikely to increase their lending to productive sectors of economy. Further many countries especially Germany and Switzerland who have sought to control the monetary aggregates have not achieved meaningful restraint on prices front.

With large foreign exchange reserve in hand, the easiest option is to reduce customs duty and liberalize the import of essential commodities. The export of commodities will be banned. The states will be asked to de-hoard the commodities. On the supply the farmers will be tempte4d with reasonable prices just to get that extra votes and dump the increases in the uncovered budget deficit.

How does this news affect the investor?

A recent survey of expenses in the last quarter by a leading audit firm found that the expenses have risen by nearly 15% for the various firms it has surveyed. The price rises cannot always be passed to the end user easily. This will affect profitability and therefore impact the earnings. Further the rupee will lose against other currencies and inflows will slow down giving the stock market further jitters. The erosion of margin will stop only when economy settles at a higher prices level, closing in the process many an inefficient firms.