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Inflation

Inflation

Inflation: the long and short of it...

Ramesh: Sheesh! Never thought this pocket money thing would back fire on me! It was better when I used to take money when I needed from Ma. Now my pocket money runs out on the 15th and I am completely broke! Tell me Pandit ji, why is it that a bar of my favourite chocolate costs me Rs 50 now when only a few months ago I could buy it for Rs 30.

Pandit ji: Arre Ramesh, the answer is pretty simple. It’s inflation! The entire population of the world is feeling the pinch. People in Haiti are eating mud cakes because food is too expensive! Everything from the expensive bottles of perfume to potatoes has become dearer.

In the past few months we have all seen creases of worry on each other’s faces right from the shopkeeper in our neighbourhood to the prime minister of our country over the rise in prices. Suddenly in every street and corner and at every discussion, inflation is the new buzzword. But what really is this inflation? Hmm... let’s explore what our textbooks and dictionaries are not telling us.

This we all know now, while reeling under inflation, that it means that there has been a rise in prices. The prices in the market vary according to the supply and demand. If supply is higher than demand then prices will be low, but if supply is lower than demand then prices will be high. The prices will keep on increasing as the gap between supply and demand will increase. But, how do we know that prices have risen? Our friends, the economists, have some complex calculations. However, very simply speaking, there is the Consumer Price Index or the CPI and the Wholesale Price Index or the WPI, which governments use to track the rate of rise in prices. The CPI is preferred world over, as it shows the impact of inflation on customer better, by calculating inflation from the way it affects consumers. In India, the WPI is used to calculate the changes in prices of commodities in the wholesale markets. The rate of inflation is calculated from the changes in prices of a basket of selected goods and services. A particular reference year (the base year currently is 1993-94) when the prices of the selected commodities were most stable is kept as a reference point and the rate of increase from prices at that year is used as an index to calculate inflation.

The WPI commodities basket contains:
  • Primary Goods like food grains, milk, vegetable, and cooking oil.
  • Fuel, power and lubricants
  • Manufactured products

 Why do prices shoot up?
Let’s now look at the reason why prices shot up recently. Many people feel that the current year’s rise in prices is due to the global trends. We need to examine how far this is true.

The global increase in prices was due to two factors. During 2007 and the first half of 2008, there was a sharp rise in prices of petrol and petroleum products. The price of petrol had increased from US$25 per barrel in 2003 to US$150 in July 2008.

There were several reasons why the price of petroleum had increased:

  --  There has been unrest in the Middle Eastern countries, which are the major petroleum producers. For example, the war in Iraq and the  standoff in Iran.

  --  The fall in stock markets across the world made investors pull out their investments from the stock market and divert it to the commodity market, which are markets where raw products are exchanged. Oil as a form of energy is widely traded, and the fluctuations in the oil markets are of particular political interest. So, oil prices were shooting up because of investor’s speculations, much in the same way as they did in to the stock market earlier.

But, why would this affect the food prices (according to IMF data food prices have almost doubled in the past two years and in the beginning of 2008 they hit the highest)? The answer lies in the twists and turns that food takes before it lands on our platter.

--  The agricultural sector depends on irrigation, fertiliser and transportation. The rise in oil prices means that the cost of transporting food to the market has become higher and the consumer consequently ends up paying more.

--  Many economies in the last decades have moved to laissez faire policies, which means that import restrictions have been
lifted and the availability of food grains have been left to the charge of market forces. Thus, a bad crop season of wheat in China has led to food riots in Indonesia.

-- Agricultural policies all over the world have been pretty shortsighted. Attention has not been paid to factors like shrinking sizes of land-holdings or the impact of shifting from food grain to crops that produce bio-fuels, or the devastating impact of climate change on land and the seasonal cycles.

Up, up and rock bottom… Now, the global trend has reversed. Fuel prices have fallen drastically in the past couple of months. As per simple logic, food prices, too, should take a downward spiral. Will they? Well, in the current era of globalisation, it is difficult to predict. Our food supply chain has become so linked with the economies of nations across the globe that upheavals and turbulences taking place may have more of an impact on food costs than just the price of oil.

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Inflation