INFLATION IS LED BY SUPPLY-SIDE CONSTRAINTS AND MONETARY TIGHTENING WON’T HELP
THERE seems to be a near consensus among economists that containing inflation through monetary tightening would prove counterproductive. Unlike in February 2007, when RBI successfully checked inflation by raising rates, they argue, this time inflation is largely supply constraint led and not demand pull driven. Any credit squeeze would, therefore, hurt both demand and supply, leaving the gap between the two largely unchanged.
“In the current scenario hike in commodity prices due to supply constraints is the issue and not the money. Bank credit for the period April 2007-February 2008 was up 16.7% over the same period last year. However the loans growth between April 2006-February 2007 was 22%. This is sure sign that demand pressure is cooling down. Thus further monetary tightening led fall in production would spell disaster for an economy finding hard to come over supply constraint led inflation,” says Jayati Ghosh, Professor of Economics at JNU.
Indeed, core inflation, which excludes the prices of fuel and agri commodities, remained higher than the headline inflation between March 2007-February 2008. This implies that the major contributor to inflation was higher prices of manufactured products. This was likley triggered by increased cost of production and lower production. The growth rate of production of manufactured goods has witnessed 2.5% percentage points decline from 11.2% during the first ten months of 2006-07 to 8.7% in the same period in 2007-08.
The wholesale price index of manufactured products had risen by modest 3.3% in financial year 2006-07. But it went up 5.2% in April 2007-February 2008, a rate much higher than annual wholesale price index for all commodities which stood at 4.1% in the same period.
Mospi secretary Dr Pronob Sen concurrs, “Prices of manufactured products had remained depressed earlier due to excess production capacities and competition from imports. However, in 2007-08 higher input costs, drop in sales and lower price realisation because of fall in consumer demand, and higher borrowing cost reduced the margin. This affected the companies ability to invest and produce more, which led to a fall in production, followed by rise in prices of end products.”
Meanwhile, the rate of rise in prices of food-grains has declined in April 2007-February 2008, down from 9.7% in 2006-07 to 6.3%, following improvement in supply condition. Take the case of wheat. As the supply of wheat increased during April 2007-February 2008 of current finacial year due to both higher domestic availability and import, the rate of rise in WPI has come down. The wholesale prices of wheat grew by 6.8% in stated periord in finacial year 2007-08 against 13% in 2006-07.