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Mechanics of

A case study

… a sustained increase in the general price level leading to a fall in the value of money.

Inflation Measurement
• Wholesale Price Indices • Consumer Price Indices
CPI-UNME Weights Base Year No of Items Centres Time Lag Frequency CPI-IW CPI-AL CPI-RL WPI Wholesale Transactions 1986-87 260 600 3W M 1993-94 435 1918 2W W

Consumer Expenditure Survey 1984-85 146-365 59 6W M 2001 120-360 78 1M M 1986-87 260 600 3W M

Sectoral weights

21 .11 10.35 3.72 52.45 Fiscal year build up 5.61 5.38 5.88 2.12 8.Alternate ways of inflation.results 2006-07 2007-08 2008-09 Year on year 5.week average 4.

Movement of Index & Inflation All Commodities .

Movement of Index & Inflation Primary Commodities .

Movement of Index & Inflation Fuel & Power .

Movement of Index & Inflation Manufactured Products .

Inflation Experience Wholesale Price Index .

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600 1.WHOLESALE PRICE INDEX 1. Handbook of Statistics on Indian Economy 2008-09.000 800 600 400 200 0 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 20 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 09 YEARS Source : RBI.400 1.200 WPI 1. .800 1.

500 1.000 500 0 19 71 19 73 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 09 Manufactured Products YEARS Source : RBI.500 3. Handbook of Statistics on Indian Economy 2008-09.500 4.000 INDEX Primary Products Fuel. . Power.000 3.000 1.WHOLESALE PRICE INDEX 4. Light & Lubricants 2.500 2.

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next week I am supposed to discuss recession in a North Goa college. Is it that while South Goa tries to douse the fires of inflation. North Goa reels under a recession ? . I am discussing inflation in a South Goa college.It’s quite interesting that while today.

that may sound like a joke. . our corporates are demanding that they continue. Our stimulus measures are still in place. but we keep on complaining of rising prices of dal. onions and sugar. At the moment we do not really know whether we need to fight inflation or recession. But it is not.Well.

. Mc Kinsey brings forth diametrically opposite views about the situation in US. In an interesting debate recently.And it’s not only we. Africa and Latin America to “over-developed” economies of US and Europe. the debate over inflation v/s recession is raging everywhere – from the emerging economies of Asia. Just a peep at the debate titled “What Matters”.

He is the coauthor. Levy is managing partner of the Jerome Levy Forecasting Center. economy facing a decade or more of slow growth. . published by HarperCollins. With the U. labor costs low. and inflation will fade away.Labor costs are the most important determinant of inflation. of ”Profits and the Future of American Society”.S. with S. David A. Jay Levy. the unemployment rate will remain high. Levy David A.

Mr. . they can rise even when the economy is slow.Over the long run. it’s the amount of money in the system that determines price levels and thus inflation rates. Ehrbar spent more than 20 years as a financial journalist at Fortune. It’s called stagflation. Al Ehrbar Al Ehrbar is chief executive of EVA Advisers. He is the author of “EVA: The Real Key to Creating Wealth” (John Wiley & Sons. a registered investment adviser. 1998). the Wall Street Journal and Corporate Finance. Earlier in his career. And yes.

and increasingly common pay cuts will continue. As long as unemployment is high. Labor costs are by far the most important long-term influence on inflation. more pay freezes. expect inflation to dwindle. Although rapidly rising commodity prices can put upward pressure on inflation in the short run.David A. inflation cannot accelerate for long without an acceleration in pay rates. . the present trend toward ever smaller pay raises. The dominant influence on price trends for years to come will be the deflationary influence of chronically high unemployment. Levy : Mild deflation in the years ahead In the decade ahead. The chance of a sustained pickup in inflation is miniscule. giving way to mild deflation.

And never has the quantity of money increased the way it did when the Fed embarked on "quantitative easing" to unfreeze the credit markets and prevent an economic free fall. . Most economists. even many New Keynesians. Unfortunately.Al Ehrbar : Why we should worry about inflation Rarely have so many been so optimistic about inflation. it could turn out that rarely have so many been so wrong. have come to accept the monetarist precept that the quantity of money is what determines the price level over the long run. A significant increase in the quantity of money relative to the output of goods and services inevitably translates into higher prices. The principal cause for concern is the vast liquidity that the Federal Reserve created in late 2008 and early 2009.

the emerging economies like India. South Africa and Brazil have managed to post decent figures of growth. .What’s happening in India? However this debate seems irrelevant to India. The fact is that while US and Europe and the best part of the developed world is still haunted by the spectre of recession. China.

. But these economies have managed to walk out of the shadow due to the dynamism of their internal economies. Does it mean they are out of the danger of recession ? No. In a globalised world that is inevitable.That does not mean that the shadow of recession did not fall on these countries.

that with growth or inspite of it. The fact is. . these countries too are in the grip of a severe inflation.Let’s cast aside all the simplistic theories about inflation and recession and look at the facts. But it is also a fact that the inflation in these countries is difficult to be understood within the neat confines of MV = PQ.

as well as manufactured commodities like sugar. . fruits. pulses. milk and milk products. which are derived from agricultural inputs. the food prices were rising as fast as @ 19%. etc. meat products. vegetables.. etc. Food here refers to agricultural commodities like cereals..The inflation in these countries has been called “food inflation” : even when the Wholesale Price Index as a whole was rising at sub 1%.

. I do not have data for all the developing countries.That gives us a clue to the critical element of the inflation that the developing countries are experiencing at the moment : prices of agricultural products. So I shall restrict myself to India only.

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many experts believe that the high prices seen may not be a result of excess liquidity induced into the economy by the government and central bank last year to combat the financial crisis.Must deal with food inflation on supply side : C Rangarajan Rising food prices in the country need to be dealt with on the supply side. but more a function of the drought last year that has dried up supplies. fuelled mainly by spiralling food prices. believes C Rangarajan.” . “Inflation in India has been fast rearing its head. though some monetary action can be expected. However. Chairman of the Economic Advisory Council to the Prime Minister.

picking up in one sector and not in another.” “And our past records suggest that when it is such a skewed inflation. says that monetary tightening may not help tame the current inflation situation. So it is being caused by a supply side problem and there has been a big drought. this usually dies down.” . “This inflation is going to peter out as has happened in the past. instead of the other sectors picking up. the Chief Economic Advisor to the Finance Minister.Monetary tightening may not help tame inflation : Kaushik Basu Kaushik Basu. because there isn’t that much of monetary buoyancy being put into the system.

? will the inflation really peter out soon ? ? ? ? is it solely a result of the drought ? is it purely a “supply side” problem ? does it not call for monetary tightening ? how do we understand this inflation ? ? .So.

Price in a free market is a resultant of demand and supply forces. To look at price rise as an exclusively supply side problem is as wrong as to look at it as an exclusively monetary problem.
This is more wrong in the context of an economy that is undergoing a structural transformation. Inflation in such an economy could be basically a manifestation of the structural changes affecting both the demand and supply sides. But not strictly “Keynesian” sense. in a “monetarist” or

To blame this inflation on just the drought is equally wrong. Yes, the drought did contribute to it; the sharp spike in prices over last one year is clearly a result of the drought.
But its persistence arises out of the structural transformation that has been taking place in the Indian economy over the last few years.

Prices

Inflation Rate
Wholesale Price Index

800 1.600 1.000 Manufactured Products 800 600 400 200 0 19 71 19 73 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 09 YEARS Source : RBI.400 Primary Products 1.WHOLESALE PRICE INDEX 1. .200 INDEX 1. Handbook of Statistics on Indian Economy 2008-09.

The data clearly shows that the prices of primary products – food and non-food agricultural products – have been rising much faster than the manufactured products over the last fifteen years or so. Last year’s drought and then the out of season rains might have caused a sudden spike in prices of agricultural products. but there is an underlying long term divergence in the movement of prices of agricultural and manufactured products. .

We need to look for the causes of this divergence in the relative demand-supply situations in the market. Supply of Agricultural Products Demand Supply of Manufactured Products .

500. crores) 2. .000.500.000.000 - Demand 54 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 08 19 51 YEARS Source : RBI.000. Handbook of Statistics on Indian Economy 2008-09.000 1.000 2.GDP 4.000 G D P (Rs.000 500.500.000 3. Demand for goods and services has been rising in recent years in keeping with the growth of the GDP.000 1.000 3.000.

besides the services. . we need to consider also the change in the composition of demand for food products. the demand for food products has also been rising. Demand for food products is a component of this total demand. Apart from the increase in the magnitude of the demand for food products.This demand has been both for the agricultural as well as industrial goods. Along with the total demand.

the so-called high value agriculture. meat) and fish.1 kg. What goes up in Indian consumers' thali is fruits and vegetables. December 27. livestock (dairy. ] Ashok Gulati is the Director in Asia. International Food Policy Research Institute (IFPRI). the NSS data shows that the average quantity of cereals consumed per person per month (weighted for rural and urban population corresponding to the 1991 and 2001 census results) has come down systematically from 12.“ Between 1993/94 to 2006/07. Business Today. eggs.” Ashok Gulati [ “Food security isn't the same as foodgrain security”.7 kg to 11. . 2009.

fisheries. while the share of foodgrains has come down from 31 per cent to 25 per cent over the same period.The composition of the production basket has also changed as is evident from the rising share of high value commodities (fruit. The value of output of these commodities has gone up from 41 per cent in Triennium Ending (TE) 1992-93 to 47 per cent in TE 2007-08. vegetables. . and livestock products).

The change in consumption preferences shows a tendency towards more “processed” foods : milk or eggs or meat in place of cereals or pulses or greens.This change has implications for both demand and supply of agricultural commodities. right now let us look at only the demand implications. Let us look at the supply implications later. and further cheese or pastries or cold meats instead of milk or eggs or meat. .

.What does this imply for demand for agricultural commodities ? Just look at what follows.

0 10.2 Forage kg — — 1.0 2.0 2.Grain and forage inputs per kilogram of animal product Livestock Grain kg Eggs Broilers Milk Cheese 11.3 0.4 Total kg 11.6 .3 1.7 17.7 7.

you increase the demand to 2. .6 kg. you increase the demand to 11 kg. when you substitute it with chicken.7 kg. you increase your demand for grains / vegetables from 1 kg to 1.What does that mean ? It means that when you substitute 1 kg of grains or vegetables in your diet with 1 kg of milk. and when you substitute it with eggs. And when you substitute it with cheese. you increase the demand to 17.3 kg.

= 1 kg = 17 kg 10 kg .

Growing Population = + + Growing Incomes Changing Diet Growing Demand for Agricultural Products .

Let us now turn to the supply side. What has happened to the supply of agricultural commodities over the last sixty years ? .

“ Inflation is high. Business Today. January 21. ] Bibek Debroy is an Economist and Professor. MGNREGS. New Delhi. Food prices have increased continuously. It does not have much to do with drought. . Because agro-cumrural reforms haven't been introduced.”. And rural demand has increased because of farmers' debt relief. 2010. some specific items being an exception. but only food price inflation. pure income effects and changes in consumption patterns.” Bibek Debroy [ “This inflation has nothing to do with monetary policy. the supply curve is inelastic. Centre for Policy Research.

0 20.0 120.Production 100.0 80.0 40.0 180.0 0.0 AGRICULTURAL PRODUCTION Years Period Of Stagnation 19 49 19 -5 0 52 19 -5 3 55 19 -5 6 58 19 -5 9 61 19 -6 2 64 19 -6 5 67 19 -6 8 70 19 -7 1 73 19 -7 4 76 19 -7 7 79 19 -8 0 82 19 -8 3 85 19 -8 6 88 19 -8 9 91 19 -9 2 94 19 -9 5 97 20 -9 8 00 20 -0 1 03 20 -0 4 06 -0 7 .0 160.0 60.0 140.

000.000.000 2.000 GDP – SECTORAL GROWTH SECTORAL GROWTH 200.000 Industry 2.000 19 51 19 54 19 57 19 60 19 63 19 66 19 69 19 72 19 75 19 78 19 81 19 84 19 87 19 90 19 93 19 96 19 99 20 02 20 05 20 08 Years Source : RBI.000 150.500.000 Agriculture Agriculture 100.000 Industry 2004 2005 2006 2007 2008 2009 1.250.000 Sectoral Output 50. .000 Services 500.000 1. Handbook of Statistics on Indian Economy 2008-09.500.

but also see the agricultural sector falling behind the industrial sector in the current decade.The graphic you have just seen gives a bird’s eye view of the sectoral growth of Indian economy between 1951 and 1909. You not only see the service sector surging disproportionately ahead of the industrial and agricultural sectors throught the period. Though this is only the broad picture. it gives sufficient evidence of a structural shift. .

Value Of Agricultural Commodities Produced Income Generated in Industry and Service Sectors .  as the quantum of incomes generated. it will help to understand the two sides of the GDP metric :  as the value of goods produced.At this point. the relative contraction of supply of agricultural commodities becomes very obvious. When we see the growth of sectoral product in the context of this dual connotation of the GDP metric.

Value Of Agricultural Commodities Produced Agriculture Industry Services Income Generated in Industry and Service Sectors 4 57 60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 .

000 12. given by “sectoral output divided by total population”. PER CAPITA SECTORAL OUTPUT Sectoral Output / Total Population 20.000 4. Handbook of Statistics on Indian Economy 2008-09.000 14.000 - Agriculture Industry Services Per Capita Output 51 55 59 63 67 71 75 79 83 87 91 95 99 03 19 19 19 19 19 19 19 19 19 19 19 19 19 20 Years Source : RBI.000 8.Let us now look at another metric to capture the same phenomenon : the per capita sectoral output.000 2.000 6.000 18.000 10. 20 07 .000 16.

while the per capita industrial and 6.000 8.000 10.000 16.000 - 6. 2.20.000 service secor output has grown.000 per person of India’s population has been almost 8.000 Output Per Capita Output Per Capita PER CAPITA SECTORAL OUTPUT Agriculture Industry Agriculture Industry 16.000 2.000 18.000 4.000 Services Services Over the last decade.000 18.000 - 2001 2002 2003 2004 2005 Years 2006 2007 2008 2009 2001 2002 2003 2004 2005 2006 2007 2008 2009 . the agricultural output 10.000 14.000 20.000 4.000 14.000 12.000 stagnant.000 12.

That takes us to a more basic question : Why has agricultural output declined relative to other sectors ? .

00 0.05 1. Allocation of labour to agriculture has been falling sharply over time.90 0. SECTORAL EMPLOYMENT 1.85 0.95 0.The resource allocation to a sector gives us a clue to the productive vitality of that sector. 20 06 .15 1.80 Primary Sector Secondary Sector Tertiary Sector 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 Years Source : RBI. The graphic below shows the allocation of labour to the three sectors.10 1.20 1. Handbook of Statistics on Indian Economy 2008-09.

.0 90.0 80. AREA UNDER CULTIVATION 140.0 130.0 110.0 70.The graphic below shows the allocation of land to the agricultural sector.0 Area 100.0 19 49 19 -5 0 52 19 -5 3 55 19 -5 6 58 19 -5 9 61 19 -6 2 64 19 -6 5 67 19 -6 8 70 19 -7 1 73 19 -7 4 76 19 -7 7 79 19 -8 0 82 19 -8 3 85 19 -8 6 88 19 -8 9 91 19 -9 2 94 19 -9 5 97 20 -9 8 00 20 -0 1 03 20 -0 4 06 -0 7 Years Source : RBI. Handbook of Statistics on Indian Economy 2008-09.0 120.0 60.

The graphic below shows the allocation of capital and technology to agriculture as reflected in the yield (kg.0 60.0 90.0 19 49 19 5 0 52 19 -5 3 55 19 5 6 58 19 -5 9 61 19 6 2 64 19 -6 5 67 19 6 8 70 19 -7 1 73 19 7 4 76 19 -7 7 79 19 8 0 82 19 -8 3 85 19 8 6 88 19 -8 9 91 19 9 2 94 19 -9 5 97 20 9 8 00 20 -0 1 03 20 0 4 06 -0 7 Years Source : RBI.0 130.0 Yield (kg / ha) 120.0 100.0 70. per hectare). AGRICULTURAL YIELD ( kg / hectare ) 140.0 110. . Handbook of Statistics on Indian Economy 2008-09.0 80.

The big question then is : Why are resources moving away from agriculture ? .

the returns in agriculture are low. In a free market for resources. the resources move where the returns are higher. .The simple answer is.

there is just one way to tackle the inflation : Bridge the demand-supply gap in agricultural produce. .Therefore.

.  Let agriculture be profitable enough to attract resources.And there are just two ways we can go about tackling demand-supply gap in agricultural produce :  Import agricultural produce to meet the shortfall in domestic production.

And over a long period of time the choice can become irreversible and. . and remember hard. worse still. we need to remember. that opting for the first – imports of agricultural produce – will make Indian agriculture even more unprofitable. however. as the recent crisis in US and Europe has demonstrated.Before we make that choice. unsustainable.

One of the most important factors in making agriculture profitable to the Indian farmer. intermediation..With reforms. “Rather oddly. is dis-intermediation. measured by gaps between what farmers get and what consumers pay.” Bibek Debroy . dis-intermediation occurs and distribution chains collapse. also seems to have increased. especially for fruits and vegetables.

.Models of disintermediation :  Government promoted marketing facilities ( APMCs / Market yards ). ITC e-Choupal).  Farmers’ marketing cooperatives.g.  Corporate – farmers tieups ( e.

We shall not go into the details of the models of dis-intermediation. as that is beyond the mandate of this session. . let us just have a passing glimpse into one successful case of dis-intermediation : ITC’s eChoupal. However.

let me present only an end result : biscuits from ITC.How relevant is dis-intermediation to inflation ? Without going over the entire dynamics of inflation once again. .

Rs. 80 per kg. 50 per kg. Sunfeast Special Cookies Check out the biscuit prices at your local baker ! . Rs.