What is the right lens for viewing India’s inflation?

My friend Srini Thiruvadanthai had flagged this speech by Prof. Pulapre Balakrishnan in 2014.  The lecture delivered on the occasion of his receiving the Malcom Adiseshiah award in 2014.

He makes useful points and it is a useful read but his points are not terribly novel. That India’s inflation is primarily caused by agricultural supply shocks and food prices and that they influence both growth (negatively) and inflation (positively, ie., higher) is not particularly new. It may be called ‘structuralist’ as opposed to ‘monetarist’, etc. That is ‘Economistspeak’. In plain English, agricultural supply factors explain India’s relative stagflationary experience compared to the West.

Frankly, a truly structuralist explanation was given by Nageswaran and Natarajan (2016): ‘Can India grow?’ [Link]. Of course, I am tooting my own horn here.

Second, his puzzle as to how potential growth could decline at the same time as actual growth was declining can be addressed by the fact that he is documenting: public sector capital formation.

Third, he is relatively less critical of UPA II (and UPA I which sowed the seeds) policies for the decline in public sector capital formation than he should be.

Fourth, if the NDA government had tried to increase public sector capital formation – as it has – while keeping up government welfare expenditure – as it has – then it explains its faith and reliance on tax terrorism and, even to some extent, demonetisation.

What are the answers to agricultural negative supply side shocks – if they are as correlated with India’s growth slowdown and inflation acceleration – the lecture is silent on those. I think Nageswaran and Natarajan (2016) is a better attempt at identifying (if not answer) the structural impediments to economic growth in India – both in agriculture and in industry.

Given his ‘structural’ view of India’s inflation, he wonders if conventional monetary policy framework, ‘inflation targeting’ was appropriate for India. ‘Inflation targeting’ works for normal economies where inflation is caused by excess cyclical growth in aggregate demand. Of course, we have different problems with an ‘inflation targeting’ regime but he raises the question – that others have raised before and after him too – of the suitability of the ‘inflation targeting’ regime in the Indian context where inflation is thought to be caused by agricultural supply shocks and where it does not arrive via the standard excess cyclical aggregate demand growth.

An important question is if the structural view of Indian inflation – the agricultural supply shcok induced view of inflation – is correct. Is it really an agricultural supply issue or is it an intermediation/rent-seeking behaviour? That is the question.

So much has been written about the difference between the farm-gate price and the retail price in India, with a good portion of it being deadweight loss (lost in transit – rotting, stolen, etc.) But, more important than that, is it really the intermediaries who are contributing to the structural view of inflation? If so, is it right to call it an ‘agricultural supply shock’?

If it is wrong to call it as such, then why is it wrong to apply standard monetary tools to combat it? After all, if financing costs are made higher, will the intermediaries not find it difficult to buy and hoard and hence, be forced to release supply to the market?

In sum, I am challenging the ‘structural’/agricultural supply shock view of India’s inflation. Pl. feel free to tell me the chinks in the argument and point to any research that delves into this issue.

2 thoughts on “What is the right lens for viewing India’s inflation?

  1. “After all, if financing costs are made higher, will the intermediaries not find it difficult to buy and hoard and hence, be forced to release supply to the market?”

    With the abysmal monetary transmission (as admitted by RBI themselves), I don’t think think argument holds much water. Even if you accept it works with lags, those aren’t optimal instruments to regulate a short supply cycles.

    The alternative question is should the MPC formally have a different inflation target? It seems some MPC members already do so from the minutes anyway, viewing headline inflation largely as noise and core inflation (excluding housing) as “signal”. Even doves like Prof. Dholakia believe headline inflation in India converges to core in the long run. I’d probably prefer core inflation ex petrol if the critique is RBI should target what it can control.

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