High prices cost growth benefits

The core inflation in foodgrain, which has been considerably high both during 1996-2000 and 2001-09, seems to have outweighed the positive effect of economic growth.

Inflation begets inflation, and the rise in the prices of one commodity impacts another.

So, the inter-relation among prices of various commodity groups and the quantity-price interaction need to be understood.

The other issue relates to the productive aspect of price rise and the non-productive aspect, also known as core inflation.

Core inflation is that component of price rise that grows due to its own momentum and, thus, does not provide an incentive to the producer.

From the consumer’s point of view, whether the core inflation component is neutralising the beneficial effect of growth is an important question.
    
To analyse the growth in prices, we have considered the following commodity groups: foodgrain; fruit and vegetables; milk; eggs; oilseeds; manufacturing products; and fuel, power and lubricants.

Our analysis is based on the monthly data from April 1996 to June 2009.

The reference point for inflation is the wholesale price index (WPI) with 1993-94 as the base.

The revised WPI, with base 2004-05, released on September 14, has not been included here.
    
Except for oilseed prices, evidence suggests that one price group impacts the other.

The clustering of prices also confirms that the rate of growth in prices of manufacturing products, foodgrain and milk are associated. Fuel and manufacturing prices are also inter-related.

Besides, the prices of fuel, fruit and oilseeds are, again, inter-connected. The causality test suggests that foodgrain prices influence the prices of the manufacturing products, but not vice versa.

The causality between manufacturing and fuel prices is bidirectional. Both fuel and manufacturing prices affect the prices of oilseeds.

Fuel prices also cause changes in the prices of foodgrain. And, the prices of foodgrain, fruit and vegetables mutually reinforce on each other.
    
Clearly, price rise in one sector has its spillover effect on other sectors — and the overall cost of living.

So, it is futile to argue that substitution possibilities between commodity groups can essentially leave the consumer unaffected by the adverse effect of price rise.
    
As for the relationship between inflation and other macro variables, declining inflation is usually expected to make the Sensex rise. Conversely, increased FII inflow may accelerate the rise of the Sensex and, in turn, fuel inflation.

But our long-term data suggest that there is no strong relationship between foodgrain and manufacturing prices with the Sensex.

Interestingly, prices of fruit and vegetables and oilseeds show a negative correlation of –0.405 and –0.135 with Sensex, respectively.

Domestic fuel prices explain only 2% of the variance in the index of industrial production (IIP). This is understandable because the domestic fuel price does not necessarily reflect the changes in international market.

The Sensex influences FDI and new investment, and, therefore, enters as a determining factor for fuel prices.

Food and milk prices, IIP and real effective rate of foreign exchange play an important role in explaining substantive variations in Sensex, which is also seen to influence the real effective foreign exchange rate.
    
Money supply influences prices of some primary commodity groups. However, if prices are believed to have an impact on the money supply, manufacturing prices reveal it clearly.

As for real interest rate, the IIP accounts for a substantive part of the variance, indicating the impact of investment demand on the cost of borrowing.
    
The overall price growth for all commodities does not seem to be much different between the two subperiods, 1996-2000 and 2001-09.

However, decomposing the price rise in terms of core and noncore inflation — the former is independent of the quantity — seems to have increased substantially in the second sub-period.

Foodgrain and manufacturing prices reveal that of the total rise, the core inflation accounted for around 96% and 91%, respectively, between 2001 and 2009, whereas their respective shares were 69% and 37% in the first sub-period.
    
This would mean that in the second sub-period, the non-productive component of inflation has gained momentum.

Besides, the manufacturing prices have caused a sharper rise in the overall inflation in the second sub-period while foodgrain prices drove inflation in the earlier period.

For controlling price rise, greater emphasis is needed on the manufacturing prices, even though foodgrain prices have grown at a rapid pace in the last year.
    
The person day unemployment rate both in the rural and urban areas increased in 2004-05 relative to 1999-2000 or 1993-94.

This is in sharp contrast to the standard Philips Curve postulation, which suggests that price rise reduces unemployment rate.

The person day unemployment rate is mostly due to underutilisation of the workforce, and this is prevalent among poor households.

Price rise possibly reduced the demand for certain services provided by the low-income households.
    
The core inflation in foodgrain, which has been considerably high both during 1996-2000 and 2001-09, seems to have outweighed the positive effect of economic growth and, thus, the extent of decline in poverty in the post-reform period has been rather modest.

The rise in manufacturing core inflation in the second sub-period suggests that the role of industry to produce mass consumption goods at a reasonably low price remains unrealised. This may have affected manufacturing exports and domestic demand adversely.