Is there a structural change in inflation?
Going by historical precedent, the slowing inflation makes a case for an RBI rate cut, and the global softness in commodity prices should further buttress that case
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The nosedive in consumer price inflation to 1.5% in June prompted Arvind Subramanian, the government’s chief economic adviser, to talk of a paradigm shift in the inflationary trajectory.
It’s not just in India that inflation is low. In the US, year-on-year (y-o-y) consumer price inflation for June fell to 1.6%, the fourth successive month the reading surprised on the downside. In the eurozone, inflation has been declining. In China, CPI inflation for June was 1.5% y-o-y, well below the government’s 3% target. And in Japan, where they celebrate rising inflation as a relief from the deflation that has plagued the economy, inflation for June came in at 0.4%, way below the target of 2%. Are we seeing global disinflation and is it a long-term trend? There are sound reasons for believing so. Oil prices, for instance, are structurally lower, with a sea change in the oil market. US crude exports are forecast to exceed that of most Organization of the Petroleum Exporting Countries (Opec) members by 2020.
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But it isn’t only oil prices. The OECD-FAO publication Agricultural Outlook for 2017-2026 says that “real prices of most agricultural and fish commodities are anticipated to follow a slightly declining trend, keeping them below previous peaks over the next 10 years”.
Metal prices are dependent on Chinese growth, with an International Monetary Fund (IMF) blog pointing out that 60% of the variation in metal prices can be explained by fluctuations in Chinese industrial production. Given the Chinese leadership’s commitment to shift the Chinese economy from an investment-driven to a consumption-oriented one, it’s likely the pressure on metal prices too will continue.
Perhaps the weightiest addition to the debate has come from the Bank for International Settlements. Its annual report raises the question whether globalization has led to persistently lower inflation. It points to labour’s declining pricing power as a result of the threat of globalization hanging over it and says that the recent tightening of labour markets in the US poses little risk of an inflation overshoot. Says the report, “One factor has been the dramatic expansion of the global labour force. In the 1990s and early 2000s, the opening up of Asia and the former Soviet bloc roughly doubled the effective labour force involved in world trade. More recently, further economic integration and increasing participation in GVCs (global value chains) have boosted international competition in labour markets. A second factor has been industrial automation. New technologies have long been a significant influence on production processes and demand for skilled labour in advanced economies. With the quickening pace and growing versatility of current robotic technologies, manufacturing labour pools face new challenges. At the same time, service sector employment, traditionally less exposed to the increased efficiency of robotics, has also become more vulnerable.”
These forces have led to an erosion of bargaining power for labour and are behind the declining share of labour in national income seen in many economies. In short, one of the main causes of inflation—wage pressure—has been kept under check in recent times, thanks to globalization and technology. Putting it another way, a part of inflation has been the end result of the ability of workers to force wage increases, but labour has become increasingly powerless in recent times and consequently one important reason for inflation is absent.
In India, there are other factors that point to lower inflation. The fiscal deficit has come down, the rupee has strengthened, the rains have been good and the government has successfully managed food prices. As Saugata Bhattacharya, chief economist at Axis Bank points out, lower increases in minimum support prices (MSPs) has been one of the structural changes brought about by the present government. Core inflation too has come down in recent months. To be sure, there are countervailing arguments—lower inflation is due mainly to lower vegetable and pulses prices, a base effect and there are concerns over the fiscal impact of farm waivers and increased house rent allowances for government employees. But all the indicators show there’s plenty of slack in industry.
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Perhaps we could take our cue from history. The consumer price index for industrial workers has a long history, so we can use it as a gauge. CPI (I-W) inflation was at an average of 1.65% for April-May 2017. In 2004-05, CPI (I-W) inflation was 3.8% for the full year and 2.67% on average for April-June. The repo rate at that time was 6%, 25 basis points lower than the current rate. GDP growth for FY2005 was 7.1%, similar to current growth, although that was under the old series. And the gross fiscal deficit, as a percentage of GDP, was higher in 2004-05 than it is now. So, going by historical precedent, there is a case for a rate cut and the global softness in commodity prices should further buttress that case.
True, a rate cut may not have much of an impact, but as A. Prasanna, an economist at ICICI Securities Primary Dealership says, that shouldn’t deter an inflation-targeting central bank.
Manas Chakravarty looks at trends and issues in the financial markets. Respond to this column at firstname.lastname@example.org.