Popular wisdom says that prevention is better than cure and a medical textbook is, therefore, useful reading in the current high inflation situation — it’s a puzzling observation that the most prevalent evidence of damage is so routinely ignored. To an astute diagnostician, both signs and symptoms are readily recognized. If therapy is not delayed until the damage is severe, the complexity and cost of treatment can be dramatically reduced.
What is the difference between signs and symptoms? Signs are seen by the expert before the symptoms are felt by the patient. Now, it is clear that the Reserve Bank of India’s (RBI) warnings on inflation pressures in January were valid: The clamour for rate cuts has been quelled. It has been evident for long now that food and oil are the high points. The current spurt, however, came in through iron ore and steel rises. Though governor Y.V. Reddy himself expressed surprise at the extent of inflation, that is a reflection more on the way data is collected and reported, rather than on his diagnostic skills going astray.
What does one do when the thermometer is faulty? On 9 May, inflation for the week ended 1 March was revised from 5.11% to 6.21%; the latest provisional inflation, still to be revised, for April-end is 7.61%. A new, more appropriate price index, which is in the pipeline, would undoubtedly show much higher rates of inflation than the current levels.
On the treatment plan, there is still doubt and debate. And with inflationary pressures to persist this year, the questions will continue to be the same. Should rates be raised? What will be the impact on growth? Aren’t there any other policy options? Shouldn’t RBI let the rupee go up? But battling the essence of inflation needs a different approach at this juncture. If we take the medical advice of looking at first signs of disease, it is quite clear that the crucial variables to examine are crude oil and food prices.
What are these prices signalling? For Matt Simmons, energy investment banker and “Peak Oil” theorist, the signs that crude was entering danger zones have been clear since 1989, but it was only post-2002 when China started its explosive growth that the situation became bleak. Earlier, demand was thought to peak at 66- 68 million barrels per day (mbpd), levels it had hit for the period 1988-1994, but this demand has already hit 88mbpd in early 2008. According to him, this unplanned-for growth has taken up 99% of spare capacity and has happened despite a 10-fold rise in prices.
Problems abound in the oil sector — the rising share of state-owned oil companies has led to secrecy on reserves data, the resultant fuzzy picture on supply estimates explains the frenzied rise in prices, aging oil wells, rising costs of extraction, chronic rig and skilled manpower shortages, etc. The list is long. Eighty per cent of oil infrastructure needs to be rebuilt; the fresh demand for steel will in turn impact inflation. The same problems were stressed by Shell India chairman Vikram Mehta recently. For Simmons, the solutions are clear, but radical — mandate a $100 floor on oil prices, create a blueprint to rebuild energy infrastructure, begin a “travel-less” programme that allows flexi-work from home, promote use of mass transport systems, etc.
With high crude prices and ethanol subsidy on corn in the US, there’s a direct link between high prices of crude, foodgrain and dairy produce. Drought in Australia and Ukraine hasn’t helped at all and the food crisis is now on the international agenda, with stocks at a 30-year low. Independent of these new pressures coming in from crude prices, were there any signs in India of a possible crisis? Government data shows declining per capita foodgrain availability since 1991, enough time to begin programmes of agricultural reform, market liberalization, more efficient targeting of food subsidies to the poor, etc. Given a growing population, rising incomes and low growth in production, a single bad monsoon is enough to upset the cart. So even without the oil shock, the picture has been clear for years — the tipping point was not far off.
Though George Bush’s statement that prosperity in India has led to global food price highs has raised Indian hackles, when production and demand are so delicately balanced, the “need versus greed” debate hits headlines. Per capita consumption of food and crude oil is much lower in China and India — to bet on a slowdown in these economies, therefore, has social ramifications as well. On the other side, high oil prices are causing prosperity in oil-rich countries; the recent debate over sovereign wealth funds is just one instance of the political implications of this growing wealth.
As Joschka Fischer, Germany’s former foreign minister, wrote last year: “The Club of Rome’s basic insight — that we live and work in a finite global ecosystem, with exhaustible resources and capacities — has returned to challenge us again.” It is not a question any longer of whether a 5% inflation or a 3% inflation is tolerable; increasingly it appears to be a question of sustaining the human population on the planet. It is time to step back and look at the larger picture of what the prices are signalling.
Sumita Kale is chief economist at Indicus Analytics. Comments are welcome at firstname.lastname@example.org