Aspects of India's Economy No. 53

In order to justify his savage cuts in developmental expenditure during 2012-13, Chidambaram told the Lok Sabha that he was compelled to make them; that, had he not done so, there would have been high inflation. “When it (the fiscal stimulus) impacted the fiscal deficit, inflation went up to 9.6 per cent in 2010-11 and then 8.9 per cent in 2011-12. Now it is 7.5 per cent. This is a consequence, inevitable. You run a high fiscal deficit, it will be inflationary,” he said. The Reserve Bank Governor D. Subbarao, too, recently pressed for a cut in the fiscal deficit, citing his concern for the “people who are hurt by inflation – the large majority of the poor .”

The theory Chidambaram uses to justify his actions – which theory is also propagated by the Reserve Bank of India – is that there is excess demand in the economy, leading to price rise. In other words, this is ‘demand-pull inflation’. That excess demand, Chidambaram claims, needs to be squeezed out of the economy by reducing Government spending and/or maintaining high interest rates. TheEconomic Survey 2012-13 confirms that recession itself is part of the inflation control package: “The government can curb demand through fiscal consolidation, while the RBI does so through high policy rates and tight liquidity. These measures may have an adverse effect on growth, but that is precisely how they curb inflation.” (p. 94)

However, the drastic reduction Chidambaram thus brought about in the fiscal deficit in 2012-13 failed to bring down high consumer inflation, which is what matters to the people. Rather, inflation in the all-India consumer price index or CPI (New Series) rose steadily from 8.8 per cent in February 2012 to 10.9 per cent in February 2013. The averages of all the consumer price indices show a rise of one percentage point or more between 2011-12 and 2012-13.[1] The latest available data show that the CPI (Agricultural Labour) is soaring, at 12.7 per cent; the CPI (Industrial Workers) is only slightly behind, at 11.6 per cent.[2] The soaring CPI indices are eating into people’s real incomes.

That this occurred despite (i) the RBI maintaining high interest rates, (ii) the fiscal deficit being reduced severely, and (iii) industrial growth plummeting to near-zero and GDP growth falling to its lowest level in a decade, shows that the theory on which the RBI and Chidambaram are justifying their actions is bogus.

Why inflation in manufactured goods has slowed
Chidambaram claims as his success the fact that Wholesale Price Index (WPI) inflation slowed considerably. However, the slowing of WPI inflation is because the basket of commodities measured (at the wholesale stage) by the WPI contains less food items and more industrial goods: manufactured goods make up 65 per cent of the basket. The price rise of manufactured goods has slowed precisely because there is an industrial recession – and this recession has been triggered by the reduction in Government spending and by high interest rates.

Table 1 presents the rate of inflation of different categories of commodities in the Wholesale Price Index during 2011-12, and then during the first three quarters of 2012-13. An examination of this Table reveals that the price rise of non-food manufactured products (Item 3) has being going down steadily. The reason is not hard to find: lack of demand. Several industries are suffering from substantial unutilised capacity.

Table 1: Inflation in Major Groups of the Wholesale Price Index (%, year-on-year)

Policy-induced steep rise in cereals prices
By contrast, the rate of price rise of primary articles (prominently agricultural commodities) has remained high. It is particularly important to note that cereals prices were the main driver of food inflation – rising at the rate of 6.4 per cent, 11.1 per cent, and 17.1 per cent during the first three quarters of 2012-13. This at a time when the Government’s granaries have been groaning with 60 million tonnes of cereals. India to its utter shame has among the highest rates of under-nutrition in the world, with nearly half our children stunted and 43 per cent underweight. Instead of ensuring the distribution of grain at cheap rates among the people, the Government, having crippled the PDS since the 1990s (especially since Chidambaram introduced ‘targeting’ in 1997), has been hoarding grain or exportingit.

Two specific decisions reduced even the available open market stocks of rice and wheat. In September 2011, the Government reversed a four-year ban on exports of non-basmati rice. In 2012, as a larger share of Thailand’s rice supplies were diverted to its domestic market, India became the world’s leading exporter of rice, exporting almost 9 million tonnes in the calendar year. Although price rise in rice had been low in 2011-12, it seems to have picked up in 2012-13. In January 2012, inflation in rice was just 0.9 per cent (in the Wholesale Price Index); by February 2013 it rose to 18.8 per cent. (See Chart)

Secondly, in 2012 the Government decided to permit wheat exports too, as part of liberalising agricultural trade. The Economic Survey 2012-13 tells us that “In recent years, the policy impetus by the government has provided much required stability to agri exports. Given sufficient stocks of foodgrains in the central pool, the government has allowed exports of 4.5 million tonnes of wheat from the central pool stock of the FCI through central public-sector undertakings and placed export of wheat and rice under open general licence (OGL)”, i.e., without any restrictions. (p. 189) Elsewhere in the same document it mentions: “Higher international prices and reduced global availability also pushed international prices upwards. This created space for exports of wheat and again reduced private availability of wheat.”(emphasis added) In other words, it was the Government’s deliberate freeing of exports which enabled traders to mint money on exporting Indian grain and importing inflation. The major exporters were international traders such as Concordia, Toepfer, Louis Dreyfus, Starcom, Glencore and Cargill.[3] These global agricultural traders and market manipulators now have a major presence in Indian agricultural trade and in shaping Government policy.

As the Government failed to distribute wheat adequately through the PDS and a portion of available open market supplies were exported, domestic open market prices rose. In the name of containing domestic price rise, the Government sold 9.5 million tonnes of wheat on the domestic open market between July 2012 and February 2013. However, this was promptly mopped up by large traders for export as well as sale on the domestic market. As the Economic Survey itself confesses, “While the FCI has undertaken open market sales for domestic use and exports, these operations have so far had limited impact on domestic prices.” (p. 91) In fact, wholesale inflation in wheat rose from -3.4 per cent in January 2012 to 21.6 per cent in February 2013. (See Chart)

Buoyed by its success in promoting exports while its people go hungry, the Government has announced that it has cleared the export of an additional 5 million tonnes of wheat, making a total of 9.5 million tonnes ahead of the new harvest season.[4] There may be some logistical difficulties in actually executing this export: “industry experts said wheat exports could prove difficult given congestion at ports which are already handling hefty private shipments of grains such as rice and oilmeal.”[5]

Government-administered rise in fuel and power prices
Next, note that fuel and power prices, which are largely Government-administered prices, have been rising steeply (Item 2 in Table 1). The Central Government has been pressing the state governments to hike electricity tariffs. Reportedly, in the 15 months ending January 2013, 18 state electricity boards have raised their tariffs in a range of 10-30 per cent.[6] The Economic Survey tells us that the diesel price increases have added, and will continue to add, to inflation, but reassures us that this will reduce “suppressed inflation”, and so this is a good thing “in the long run”.

The theory here is that the “long run”, a decline in ‘demand-pull’ inflation – as a result of Government reducing its spending on the petroleum subsidy – will compensate for the immediate, direct cost-push inflation resulting from the price hikes. Behind this lurks the notion that any Government interference in prices is ultimately counter-productive; the ‘invisible hand’ of the market should be left to do its job of delivering the best of all possible worlds.

It is revealing that those who, in the name of the laws of the market, call for the reduction of the ‘subsidy’ on petroleum products do not also call for the reduction or elimination of all Government taxes (i.e., negative subsidy) on petroleum products, which outweigh the subsidies. With the step-by-step elimination of diesel subsidies that has begun in January 2013, the negative net subsidy will keep rising. The free-marketeers’ silence about the ‘market distortion’ caused by this negative subsidy shows that their views are not based on belief in the invisible hand delivering optimal conditions, but on ruling class interests: They wish to increase the indirect taxation of the people, and wish at the same time to deregulate pricing in the public sector-dominated domestic oil marketing sector so as to make it attractive for private firms such as Reliance, Essar and Shell (to whom that sector is about to be gifted on a platter) to expand their operations.

Elaborating further the argument for raising diesel prices, the economist deputy chairman of the Planning Commission, Montek Singh Ahluwalia, said that the diesel price hike will have a “benign” impact on prices: “When you have a suppressed price and you raise that price, then the people who are paying that higher price will have less money left to buy other things and that will soften the pressure in the market on other prices.” So, it is a “wrong notion”, he said, that diesel price hikes raise inflation.[7]

However, diesel is an input into all commodities, even agricultural goods, so an increase in the price of diesel results in an increase in prices of all commodities. To the extent that working people’s nominal incomes do not rise to compensate for this [8] (that is, their real incomes fall), this slows the rate of inflation. This is the “benign impact” on prices which Ahluwalia really looks forward to; the impact on the people is anything but benign. But further, it is likely that, with repeated cost-push measures through hikes in Government-administered prices (in order to cut the fiscal deficit), we will nevertheless see continued inflation even amid an industrial recession.

Are wages to blame?
The RBI advances another explanation for inflation: Wages. It finds that rural wages have been rising in real terms (after discounting for inflation) since 2007-08, with figures available till October 2012. It claims that “in the recent period causality ran from wages to prices, indicating that increase in real wages has been feeding into the cost of production and also sustaining demand, thereby leading to higher prices.” It claims that “There has been a significant increase in the cost of production in agriculture, driven largely by the increase in wage costs.” Secondly, “There is also evidence that increasing wage costs are a source of concern even in the organised sector. Private sector surveys indicate that wage increases in India are much higher than in other emerging market and developing economies.” The RBI calls for maintaining a close vigil on the “wage inflation spiral”. [9] The implication is that the Government should reduce its spending, which is leading to excess demand; in particular it should not spend on NREGS, which is leading to an increase in rural wages, feeding into the cost of production of crops, as well as sustaining demand.

First, to attribute price rise to wages reveals the RBI’s class bias. Let us take industrial prices: Once you subtract all costs from total income, the remainder is shared between wages and profits. If indeed wages rise, that need not lead to any increase in price, as long as the capitalist reduces his profit margin. So when the RBI finds that wage costs are a “sign of concern”, its real concern is to protect the profit margins of the capitalists at the cost of the labourers. By contrast, during the previous two decades, as the real wages of industrial workers fell (as shown by data of the Annual Survey of Industries), the RBI did not stay awake at night worrying.

Secondly, even if real wages were to rise, the profit margin of the capitalist may be protected if each worker produces more, as has been the case. Indeed, during the last two decades there was a double benefit to the capitalists: declining real wagesand rising productivity per worker. As a result, as the Economic Survey 2012-13points out, “Total emoluments as a percentage of output have consistently declined from 40.6 per cent in 1980-81 to 22 per cent in 2010-11…. The increase in profitability of organised manufacturing has depended on the reduction of these two ratios [wages/output and interest/output], and [the profit/output ratio] improved from 18.5 per cent in 1991to 53.8 per cent in 2007-08 before moderating to 47.8 per cent in 2010-11.”

Thirdly, rural labourers have the lowest consumption of any section of society, so any increase in demand from them should be welcomed, not warned against. There does seem to have been some recovery in rural wages. Real wages (i.e., after discounting for inflation) for agricultural labour stagnated or slightly declined for the seven years 1999-2000 and 2006-07, the period of rapid growth in the economy; however, they rose significantly since 2007-08.[10] From 2008-09 to 2011-12 the compound annual growth rate of real wages for rabi season agricultural labour was about 9 per cent.[11] At the same time, agricultural GDP in 2011-12 was 43 per cent higher in real terms than it was in 1999-2000. As such, it seems that agricultural labour is still only making up lost ground in its share in output. However, already there are signs that, because of the steep rise in prices (running at 12.7 per cent in February 2013) paid by agricultural labour for their basket of commodities for consumption, the improvement in real wages of agricultural labour is slowing down.

In any case, to attribute inflation in agricultural products to the rise in agricultural wages is far-fetched. Labour costs are between one-third and a half of cultivation costs, but only a portion of the labour costs are of hired labour. For example, of operational costs of Rs 15,097 for cultivation of one hectare of wheat in Madhya Pradesh in 2010-11, the hired human labour costs were Rs 1,663, and family labour was valued at Rs 2,915.[12] So even a 20 per cent increase in hired labour costs would be Rs 332/hectare, which cannot explain the rise in retail prices of wheat. The point is, between costs of cultivation and the retail price of agricultural products, there is a large gap which consists of costs of procurement, transport, storage, distribution, and of course trading margins. The RBI, like the princess in the fairytale, finds, under multiple mattresses, the pea that is bothering it – namely, the rise in agricultural wages.

Moreover, there are sizeable increases in other costs of cultivation in the last few years, as can be seen from the table of wholesale prices of certain inputs. The prices of these inputs are largely determined by the Government itself (‘administered prices’).

Finally, as we have noted earlier, there are clear explanations for the recent price rise in certain agricultural commodities such as wheat and rice (namely, allowing exports), which have driven overall price rise. Only the RBI’s determination not to seek the causes of the current inflation in the Government’s policy and in the profit margins of industry and trade can explain its pinning the blame or inflation on agricultural labourers.

Now to conclude regarding the “inevitable” relation Chidambaram claims between the fiscal deficit and inflation: (i) consumer inflation has not fallen, but risen, despite slashing the fiscal deficit; and (ii) the main contributors to the rise in prices are goods such as agricultural commodities, or goods whose prices the Government itself fixes. The prices of these goods need to be brought down by Government action – to stop exports, curb speculation, promote agricultural production, procure and properly store crops, and distribute them cheaply to the public; and to keep down the prices of petroleum products, coal, and electricity.

However, the entire thrust of Government policy is in the opposite direction. The year 2013-14 promises to continue along the lines of 2012-13 – namely, industrial stagnation and cost-push inflation.

Notes:

[1] New Series, Industrial Workers, Agricultural Labour, and Rural Labour. Economic Survey 2012-13, p. 80; data for 2012-13 is April-December 2013. (back)

[2] Agricultural Labour figure relates to February 2013, Industrial Workers to January 2013. http://www.mospi.nic.in (back)

[3] “Cabinet may ask private players to export wheat”, Economic Times, 8/3/13. (back)

[4] The Government is justifying this by pointing to the fact that there are huge stocks of wheat, and there is not enough storage space for the incoming harvest; but this crisis is of their own making, because they have failed to distribute the grain stocks. (back)

[5] “Government to prioritise wheat exports to slash grain mountain,” Economic Times, 7/3/13. (back)

[6] Srivatsa Krishna, “Government effort for power tariff hikes to face challenges”,Indian Express, January 3, 2013. (back)

[7]“Diesel price rise will have a ‘benign’ effect on inflation: Montek”, Business Standard, 19/1/13. (back)

[8] Since the majority of the workforce is in the unorganised sector, and even much of the organised sector workforce is composed of unorganised workers, the ability of the working people to get compensated for inflation is limited. (back)

[9] RBI, Macroeconomic and Monetary Developments, 3rd Quarter 2012-13, January 2013. (back)

[10] Yoshifumi Usami, “Recent Trends in Wage Rates in Rural India: An Update”,Review of Agrarian Studies, 2(1), 2012. (back)

[11] The average of five operations i.e. ploughing, sowing, weeding, transplanting and harvesting. Commission for Agricultural Costs and Prices, Price Policy for Rabi Crops: Marketing Season 2013-14, August 2012. (back)

[12] Ibid. Of course, the labour-hiring peasant does feel the pinch of rising agricultural wages, since it is the only component in the cost of cultivation that can be negotiated, and the more he/she pays, the less remains for the labour-hiring peasant. (back)

[1] Credit Suisse, India Financial Sector: House of Debt, August 2012. (back)


No. 53, May 2013