Government panic stokes inflation

When inflation accelerates, as is the case today, governments across the globe tend to panic and rush out with anti-inflationary packages. The trouble is that governmental panic itself has become a new cause of further inflation. That is why inflation in India-and in other developing countries — is not going to fall anytime soon.

Inflation comes in many varieties. The worst variety, from the viewpoint of politicians, is food-led inflation. In a poor country like India, where half or more of family spending is on food, rising food prices spell electoral doom.

The government is panic-stricken today because food prices are going through the roof. Overall, wholesale price inflation has accelerated from 4.5% in January to almost 7% today, and looks headed for double digits. Consumer prices are rising even faster because of consumer panic. The consumer price index is available only with a lag of two months, but newspaper reports suggest that in some cities the consumer price of rice is up 20%, edible oils 40%, dairy products 12% and some pulses 20%.

The government had already banned the export of wheat last year, and has now banned the export of maize and pulses. It has raised the minimum export price of rice to $1,000/tonne, at which price only the luxury basmati variety can be exported economically. Import duties on edible oil and grain have been abolished. This means that the government’s focus has suddenly shifted from protecting Indian farmers against cheap imports to protecting the consumer by cheapening imports.

Will the anti-inflationary package work? I doubt it. Prices are not shooting up in India because of drought or production shortfalls. Indeed, the harvest this year may be among the highest ever. The problem is that world prices have skyrocketed. And we live in an era of internet-savvy farmers who know exactly what food prices are in Chicago and London, and adjust their own actions accordingly. The government hopes that by banning exports, it can keep Indian food prices well below world prices.

This may be possible temporarily for wheat, since wheat harvesting is in full swing right now. But wheat farmers know well that world prices are 40% higher than in India. So many farmers, especially the bigger ones, will hold back their crop during the coming procurement season, hoping to sell at much higher prices in later months. That in turn will mean lower wheat arrivals in the procurement season — maybe only 12 million tonnes instead of the expected 15 million tonnes. And that shortfall will further spur inflationary expectations.

The problem is being compounded by global panic. Two successive droughts in Australia, plus the diversion of one-third of the US maize crop to ethanol, have led to shortfalls in world production and low food stocks.

Many food-deficit countries have sought to import more. In consequence the world price of rice in the last six months has shot up 60%, wheat by 40%, and soybean oil by 40%.

Exporting countries were initially happy with rising export prices. But as world demand pushed their domestic prices to alarming levels, exporting governments began imposing curbs on exports to tame local prices. But this reduced supplies to the world market, and sent world prices spiraling even higher. Thus, panicky efforts to curb food prices through export bans have, unwittingly, exacerbated inflation.

Ukraine, one of the biggest wheat exporters in the world, has curbed exports. So have Russia and Kazakhstan. Argentina has levied high export taxes on soybean and beef exports. India, Vietnam, Indonesia and Cambodia have curbed rice exports. So too has Thailand, traditionally the world’s biggest rice exporter. This has created panic in Thai markets. Far from falling, the price of rice jumped up by $ 75/tonne in Thailand last week, since its export curbs sent world prices up further, and had a knock-on effect on local prices.

The lesson is clear. Curbing exports is a form of national hoarding. If every country tries to hoard food, food prices will naturally rise. Governments would like to believe that hoarding by traders is terrible, whereas hoarding by governments promotes the public interest. But the impact on prices is exactly the same in both cases. Indeed, when governments start to hoard food out of panic, the panic itself stokes further inflationary fears.

That is why I am not optimistic about the Indian government’s anti-inflation package. The government thinks it is improving domestic supplies and hence bringing down prices. In fact the government is adding to the global hoarding problem, and stoking panic too. So, expect food inflation to keep rising in coming months.

When and how will it end? The roots of today’s food inflation are global, and cannot be tackled by the Indian government in isolation. Inflation will come down only when world food production rises, and world prices fall. That cannot happen immediately.

But the prospects for 2009 are not bad. After two droughts in a row, the chances are that Australia will have a good crop this year. Today’s high prices ought to induce farmers across the globe to grow more. The resultant bumper harvest could cool prices by early 2009, just in time for the next general election. That, rather than the anti-inflationary package, may save the government’s bacon.

What do you think?