Commodities: Soft target for inflation
INFLATION GENIE is out of bottle…
…not here to fulfill the wishes for free but to give sleepless nights to the people who have to spend more on their living.
When inflation accelerates, governments across the globe rush out with anti-inflationary packages, especially in a country like India, where, as estimated, 25% of population is living below the poverty line.
In India, inflation is measured as change in the Wholesale Price Index (WPI) since the comparable week a year ago tracking the data on price level of 435 commodities. The commodities are divided into three categories:
· Primary Articles (Weight 22.02%)
· Fuel, Power, Light & Lubricants (Weight 14.23%)
· Manufactured Products (Weight 63.75%)
As can be seen from the graph, India’s inflation rate is on the rising trend since last 5 months creating the worrisome situation for politicians, policy makers and above all, the middle and lower class people.
Indian government has, till now, initiated many corrective steps to contain this continuous rise in inflation, like cut customs duties on edible oils, disallowed export of non-basmati rice and cement, extended ban on pulses exports for another year to soften inflation and scrapped export incentives for rice, steel and cement.
Apart from that, the rapid increases in the prices of many commodities, especially basic food commodities, taking weekly inflation to 3 and a halfyear high of 7.41%, for the week ending 29th March 2008, has raised questions in the mind of many people, including politicians and farmers, that futures trading is the root for the spike in inflation rate, who are demanding ban on future trading of some commodities.
Will a ban on future trading in commodities really help in arresting the rising prices?
Let’s check out some facts, proving that the idea of such a ban will not suffice in overcoming the current inflationary problem…
Fundamental factors behind inflation…
· Demand-supply mismatch, which has become a global issue for worry, is the main factor behind the current inflationary situation. World’s major countries like Japan, Australia, South Africa, India, USA, China, etc. are suffering from high inflation.
According to the UN Food & Agriculture Organisation (FAO) and the European Bank for Reconstruction & Development, world food prices rose 40% last year which are fuelling inflation globally and have become a concern for many governments. Since January 2008, international rice prices have seen a steep increase of 20%, according to FAO’s All Rice Price Index alongwith increasing prices of most cereals, wheat and maize resulting from dwindling cereal supplies and rising demand.
It has been argued that these developments are largely demand driven, being the result of several years of rapid global growth and the voracious demand from some fast-growing countries such as China and India. Additionally, the impact of high oil prices, first, affecting agricultural costs directly because of the significance of energy as an input in the cultivation process itself (through fertiliser and irrigation costs) as well as in transporting food and second, promotion of bio-fuels as an alternative to petroleum which has led to significant shifts in acreage as well as use of certain grains in many countries including US, Europe and Brazil.
Import of commodities with high prices internationally affects domestic prices. Many of the commodities, included in WPI, are being imported resulting in the impact of prices prevailing in the international market on the domestic prices and as rising inflation has become the global issue it can be said that India has imported inflation to some level.
As can be seen in the case of edible oil, India imports around 50% of its annual 11 million tonne consumption of Edible Oil. Globally, the prices of Edible Oils are on the rising spree due to increase in demand resulting from the greater diversion of these commodities to produce bio-fuels. This can be taken as the fact behind the domestic rise in prices of Edible Oil.
Last year’s ban on wheat, tur, etc. is a lesson…
In early 2007, Government banned future trading in some commodities with the aim to arrest the rising inflation. On 23rd January “Urad and Tur” and then on 28th February “Wheat and Rice” were banned to be traded in the future market.
But since then prices of these commodities have moved in the opposite direction from the government’s expectation thereby showing the negligible impact of the ban on the prices.
Wheat prices, which were ruling at Rs 1,100 a quintal when trading was banned, have marginally increased to Rs 1,130 while rice prices have gone up from Rs 1,245 to over Rs 1,700 a quintal. Tur has increased from Rs 2,340 to Rs 2,720 per 100 kg, which even reached to Rs. 3,050 in Nov’07 in Maharashtra. Urad prices, however, have slipped from Rs 3,550 a quintal to Rs 2,600 a quintal.
Traded vs. Non-traded commodities…
According to the study conducted by NCDEX, some of the commodities that are not traded in futures market have shown greater percentage increase in prices as compared to the commodities traded.
A basket of 15 commodities traded on the exchange were included in the study showing a year-on-year price increase of 5.84% as against 9.04% for nearly 30 items not traded in the futures market. Certain items have shown price increase of as much as 47-48%, but these were both in the traded and non-traded baskets.
The above discussed factors proves that measures like ban on future trading of commodities is not a good idea as the prices are bound to move due to the fundamental factors like supply shortage. Instead, such a ban would deprive off from the benefits availed trough future trading like price discovery, price risk hedge, bringing reforms in logistics and warehousing sector, help in standardisation and grading of various agro-commodities and dissemination of current prices in rural areas to create awareness among the farmers.
The government is rather expected to take corrective measures which could provide a relief to the country from the current critical situation and in the long run too, while taking the global situation in due consideration and also the long term impacts of such measures.
Government is first required to overcome the various flaws in the calculation of inflation (as detailed below), which could thereafter show the true picture of country’s inflation growth.
Flaws in the calculation of Inflation……
· Non-inclusion of service products still when service sector contributes 55% to the country’s GDP
· The prices of the items included in WPI are to be revised from time-to-time to reflect the changes, but currently WPI includes large number of items whose prices have not changed since long time. Combined weight of such static items in WPI, including household items, fertilizers and pesticides, electrical appliances, etc., is more than 10%
· According to one of the prominent economists, out of 435 commodities included in the WPI, over 100 have ceased to be important from the consumption point of view. Some of the WPI commodities include coarse grains that go into making of livestock feed. But they continue to be considered while measuring inflation.
· The current WPI measures headline of inflation and don’t provide an accurate measure of the price rise that consumers face at the retail level. WPI, that was constituted in 1993-94 and has remained unchanged since then, needs a revision in the way of measuring the inflation.
The government is working to recast WPI since last three years and a committee headed by Abhijit Sen was also set up in 2005, which suggested to revise the currently used base year, i.e. 1993-94, to 2001-02. Also the doubling of the number of commodities included in WPI is also suggested, along with, the revision in the weightage of some commodities like sugar, fuel, etc. But the government has taken no steps yet in the recommended direction.
Instead of cursing future trading in commodities for these historical price rises, Government should seriously consider to bring “second green revolution” to meet the voracious appetite for food grains in the country. Rather, it is required worldwide.
