Inflation is on the radar screen
Friday, 13 May 2011
Dr B K Mukhopadhyay
Whither the global economy! While the International Monetary Fund (IMF) predicts the world economy will expand 4.4 per cent this year (a slight increase from the 4.2 per cent it forecast in October 2010 - the change being the result of a stronger-than-anticipated recovery in the second half of 2010 and the likely effects of U.S. moves to boost the world's biggest economy), the prediction of 4.5 per cent growth in 2012 remains unchanged. As the global economic situation stands now, the facts and circumstances cannot be termed as a smooth one. It is a fact that of late the global rebound has picked up a bit of steam -- in advanced economies, though activity has moderated (less than expected), yet growth remains subdued, unemployment is still high, and renewed stresses in the euro zone periphery are contributing to downside risks. Britain and half of the euro zone (Britain is a member of the EU but not in the euro zone) still qualify as economic disaster areas. Growth in many countries is anemic to negative; unemployment is high. Side by side, in many emerging economies, activity remains buoyant, inflationary pressures are emerging, and there are now some signs of overheating. But the global economy could be in jeopardy unless wealthy countries show more resolve in attacking debt problems, and "emerging powerhouses keep their simmering economies from boiling over", the IMF warns. Inflation has become a serious issue in a number of emerging markets, requiring policy makers to try to slow the flows of capital rushing into their economies-steps that could sharply curb growth and demand for commodities if they are not implemented carefully. In addition, many countries' freelance experiments with capital controls have included efforts to keep their currencies from appreciating, reinforcing an obstacle in the way of a balanced global economy. Very correctly, the "downside risks to the recovery remain elevated," as the IMF observed, points to the need for financial reform in advanced economies, action on euro zone troubles, and policies to keep inflation in check in key emerging economies. Fears of inflation are mounting in several countries, raising the prospect of higher interest rates in regions that can ill afford them in this stage of recovery. Inflation has made a rude comeback in the European Union. The German inflation rate, reported on May 6, increased to 1.9 per cent in December from November's 1.6 per cent, the fastest rise in two years. Consumer prices rose 1.2 per cent, the biggest gain since late 2002. "It seems that with ever sticky UK inflation and a more hawkish sounding European Central Bank, it is not only emerging markets who are the ones who need to be watching price pressures," observed Scotia Capital currency strategist Sacha Tihanyi. ". This is not a trend that will reverse anytime soon as broad commodity price measures, like the [Commodities Research Bureau], keep making new weekly highs." Inflation is also the euro zone's latest headache. The European Central Bank is obsessed with "price stability". Even China which finished 2010 with a so-called bang with a claim that the growth soared past forecasts, inflation slowed less than expected - numbers that could prod the government to intensify its easy-does-it approach to tightening. If the current trends are of any indication the rising food costs shows and indicates inflation would rebound in coming months. In fact, inflationary pressure has been intensifying into January and the tightening pressure would intensify especially considering the fact that the GDP growth during the fourth quarter had been stronger than expected. As per the National Bureau of Statistics, the annual gross domestic product growth in China jacked up to 9.8 per cent from third quarter level of 9.6 per cent. Full year growth was higher at 10.3 per cent compared to 9.2 per cent in 2009. It has raised bank's required reserves seven times since start of the last year with its most recent increase taking effect some weeks back. As the interest rates has been increased only twice during this period it has been suggested that more forceful moves are required to tackle the ongoing situation. It has rightly been opined that Beijing requires more work to keep the economy on an even keel as risks are skewed to more actions that are truly aggressive. The position as it stands now: though weekly food price movement points to a decline in inflationary pressure, yet any slowdown in inflation could at best be temporary. No doubt, economies like China and India have already acted, but other areas are showing signs of stress, as well. In the euro zone today, for example, one purchasing managers' index showed factories struggling with the sharpest increase in prices since it began its tracking in 1997. Some economies have been seriously wounded by the monetary union's debt crisis, while others, such as Germany, are running strong. Rightly, the European Central Bank chief Jean-Claude Trichet issued a call to arms among monetary authorities around the world. Accordingly "..all central banks, in periods like this where you have inflationary threats that are coming from commodities; have to.be very careful that there are no second-round effects on domestic prices". India's case may be seen on this score. It has been a fact that India after independence has had a more stable record with respect to inflation than most other developing countries. Since 1950, the inflation in Indian economy has been in single digits for most of the years - between 1950-1960 inflation on an average was at 2.00 per cent; while between 1960-1970 it was on an average at 7.2 per cent and then between 1970-1980 it hovered at around 8.5 per cent. What is to be mentioned here is the fact that inflation in India, that acted as a menace, was also at a 30 year low - inflation ended at a low of 0.61 per cent in the week ended May 9, 2009 after reaching a 16 year high of 12.91 per cent in August 2008, bringing in a temporary sigh of relief to policy makers. The Reserve Bank of India (RBI) paused its cycle of rate hikes over the last two months, but recent rhetoric has been increasingly hawkish, with Governor Dr Duvvuri Subbarao warning that India faces a "surge in inflation", and the government also expressing clear support for more aggressive action to get inflation lower. Whatever be the experienced efficacy or strength of the weapons - tinkering around well-known laid down formulae - cautiously avoiding the open secret--existence of black money paving the path for parallel economy-- it is clear that the outlook doesn't suggest a pullback anytime soon. It is clear that in today's complex global economic situation, inflation is caused not by one factor rather it is caused due to the interplay of a number of economic factors: (a) when the governments of a country print money in excess, prices increase to keep up with the increase in currency; (b) increase in production and labour costs, have a direct impact on the price of the final product, resulting in inflation; (c) when countries borrow money, they have to cope with the interest burden, which, in turn, results in inflation; (d) high taxes on consumer products; (e) demands pull inflation, wherein the economy demands more goods and services than what is produced; and (f) cost push inflation or supply shock inflation, wherein non availability of a commodity would lead to increase in prices. So what is the Indian central bank to do? The foremost question is whether raising rates would actually tame inflation. It may not, if one considers that some degree of inflation is imported. The regulator can do little to prevent the prices for imported food and fuel from rising. For example, it also has to factor in the possible effects of the rise in the value-added tax-a hike which could be a one-off event that probably skews the inflation figures. Naturally, any short cut remedy is better avoided. In its related Global Financial Stability Report, the IMF warned the stability of the global financial system is "still not assured" and "significant policy challenges remain". Accordingly, global economic growth will continue to be uneven -- advanced economies like the United States, Canada, Japan and much of Europe will grow by 2.5 per cent on average in each of the next two years, of course a pace too slow to significantly reduce joblessness. The world's emerging economies - China, India and Brazil - will expand by an average 6.5 per cent in both years, underscoring their need to keep a lid on things without snuffing out the global recovery they have been driving. G20 major economies have a long way to go before their repeated pledges to map out a "strong, balanced and sustained world recovery" are fulfilled. The necessary shifts in demand around the globe - the United States needs to export more, for instance; governments as well as households in advanced nations must learn to live within their means; and countries such as China need to import more and save less - are happening slowly, as are efforts to bolster banks' abilities to withstand economic shocks. The cyclical fluctuations are to be tackled through more global cooperation and interactions. We have to remember that the mortgage crisis of 2007 in the US best illustrated the ill effects of inflation. Housing prices increased substantially from 2002 onwards, resulting in a dramatic decrease in demand. Let it not get repeated. Inflation creates economic uncertainty, a dampener to the investment climate, slowing down growth and finally reducing savings and thereby consumption. The Writer, a Management Economist, is Associate Professor, NERIM, Guwahati and visiting faculty, Department of Business Administration, Gauhati University, Guwahati, India. He can be reached at e-mail: m.bibhas@gmail.com
Whither the global economy! While the International Monetary Fund (IMF) predicts the world economy will expand 4.4 per cent this year (a slight increase from the 4.2 per cent it forecast in October 2010 - the change being the result of a stronger-than-anticipated recovery in the second half of 2010 and the likely effects of U.S. moves to boost the world's biggest economy), the prediction of 4.5 per cent growth in 2012 remains unchanged. As the global economic situation stands now, the facts and circumstances cannot be termed as a smooth one. It is a fact that of late the global rebound has picked up a bit of steam -- in advanced economies, though activity has moderated (less than expected), yet growth remains subdued, unemployment is still high, and renewed stresses in the euro zone periphery are contributing to downside risks. Britain and half of the euro zone (Britain is a member of the EU but not in the euro zone) still qualify as economic disaster areas. Growth in many countries is anemic to negative; unemployment is high. Side by side, in many emerging economies, activity remains buoyant, inflationary pressures are emerging, and there are now some signs of overheating. But the global economy could be in jeopardy unless wealthy countries show more resolve in attacking debt problems, and "emerging powerhouses keep their simmering economies from boiling over", the IMF warns. Inflation has become a serious issue in a number of emerging markets, requiring policy makers to try to slow the flows of capital rushing into their economies-steps that could sharply curb growth and demand for commodities if they are not implemented carefully. In addition, many countries' freelance experiments with capital controls have included efforts to keep their currencies from appreciating, reinforcing an obstacle in the way of a balanced global economy. Very correctly, the "downside risks to the recovery remain elevated," as the IMF observed, points to the need for financial reform in advanced economies, action on euro zone troubles, and policies to keep inflation in check in key emerging economies. Fears of inflation are mounting in several countries, raising the prospect of higher interest rates in regions that can ill afford them in this stage of recovery. Inflation has made a rude comeback in the European Union. The German inflation rate, reported on May 6, increased to 1.9 per cent in December from November's 1.6 per cent, the fastest rise in two years. Consumer prices rose 1.2 per cent, the biggest gain since late 2002. "It seems that with ever sticky UK inflation and a more hawkish sounding European Central Bank, it is not only emerging markets who are the ones who need to be watching price pressures," observed Scotia Capital currency strategist Sacha Tihanyi. ". This is not a trend that will reverse anytime soon as broad commodity price measures, like the [Commodities Research Bureau], keep making new weekly highs." Inflation is also the euro zone's latest headache. The European Central Bank is obsessed with "price stability". Even China which finished 2010 with a so-called bang with a claim that the growth soared past forecasts, inflation slowed less than expected - numbers that could prod the government to intensify its easy-does-it approach to tightening. If the current trends are of any indication the rising food costs shows and indicates inflation would rebound in coming months. In fact, inflationary pressure has been intensifying into January and the tightening pressure would intensify especially considering the fact that the GDP growth during the fourth quarter had been stronger than expected. As per the National Bureau of Statistics, the annual gross domestic product growth in China jacked up to 9.8 per cent from third quarter level of 9.6 per cent. Full year growth was higher at 10.3 per cent compared to 9.2 per cent in 2009. It has raised bank's required reserves seven times since start of the last year with its most recent increase taking effect some weeks back. As the interest rates has been increased only twice during this period it has been suggested that more forceful moves are required to tackle the ongoing situation. It has rightly been opined that Beijing requires more work to keep the economy on an even keel as risks are skewed to more actions that are truly aggressive. The position as it stands now: though weekly food price movement points to a decline in inflationary pressure, yet any slowdown in inflation could at best be temporary. No doubt, economies like China and India have already acted, but other areas are showing signs of stress, as well. In the euro zone today, for example, one purchasing managers' index showed factories struggling with the sharpest increase in prices since it began its tracking in 1997. Some economies have been seriously wounded by the monetary union's debt crisis, while others, such as Germany, are running strong. Rightly, the European Central Bank chief Jean-Claude Trichet issued a call to arms among monetary authorities around the world. Accordingly "..all central banks, in periods like this where you have inflationary threats that are coming from commodities; have to.be very careful that there are no second-round effects on domestic prices". India's case may be seen on this score. It has been a fact that India after independence has had a more stable record with respect to inflation than most other developing countries. Since 1950, the inflation in Indian economy has been in single digits for most of the years - between 1950-1960 inflation on an average was at 2.00 per cent; while between 1960-1970 it was on an average at 7.2 per cent and then between 1970-1980 it hovered at around 8.5 per cent. What is to be mentioned here is the fact that inflation in India, that acted as a menace, was also at a 30 year low - inflation ended at a low of 0.61 per cent in the week ended May 9, 2009 after reaching a 16 year high of 12.91 per cent in August 2008, bringing in a temporary sigh of relief to policy makers. The Reserve Bank of India (RBI) paused its cycle of rate hikes over the last two months, but recent rhetoric has been increasingly hawkish, with Governor Dr Duvvuri Subbarao warning that India faces a "surge in inflation", and the government also expressing clear support for more aggressive action to get inflation lower. Whatever be the experienced efficacy or strength of the weapons - tinkering around well-known laid down formulae - cautiously avoiding the open secret--existence of black money paving the path for parallel economy-- it is clear that the outlook doesn't suggest a pullback anytime soon. It is clear that in today's complex global economic situation, inflation is caused not by one factor rather it is caused due to the interplay of a number of economic factors: (a) when the governments of a country print money in excess, prices increase to keep up with the increase in currency; (b) increase in production and labour costs, have a direct impact on the price of the final product, resulting in inflation; (c) when countries borrow money, they have to cope with the interest burden, which, in turn, results in inflation; (d) high taxes on consumer products; (e) demands pull inflation, wherein the economy demands more goods and services than what is produced; and (f) cost push inflation or supply shock inflation, wherein non availability of a commodity would lead to increase in prices. So what is the Indian central bank to do? The foremost question is whether raising rates would actually tame inflation. It may not, if one considers that some degree of inflation is imported. The regulator can do little to prevent the prices for imported food and fuel from rising. For example, it also has to factor in the possible effects of the rise in the value-added tax-a hike which could be a one-off event that probably skews the inflation figures. Naturally, any short cut remedy is better avoided. In its related Global Financial Stability Report, the IMF warned the stability of the global financial system is "still not assured" and "significant policy challenges remain". Accordingly, global economic growth will continue to be uneven -- advanced economies like the United States, Canada, Japan and much of Europe will grow by 2.5 per cent on average in each of the next two years, of course a pace too slow to significantly reduce joblessness. The world's emerging economies - China, India and Brazil - will expand by an average 6.5 per cent in both years, underscoring their need to keep a lid on things without snuffing out the global recovery they have been driving. G20 major economies have a long way to go before their repeated pledges to map out a "strong, balanced and sustained world recovery" are fulfilled. The necessary shifts in demand around the globe - the United States needs to export more, for instance; governments as well as households in advanced nations must learn to live within their means; and countries such as China need to import more and save less - are happening slowly, as are efforts to bolster banks' abilities to withstand economic shocks. The cyclical fluctuations are to be tackled through more global cooperation and interactions. We have to remember that the mortgage crisis of 2007 in the US best illustrated the ill effects of inflation. Housing prices increased substantially from 2002 onwards, resulting in a dramatic decrease in demand. Let it not get repeated. Inflation creates economic uncertainty, a dampener to the investment climate, slowing down growth and finally reducing savings and thereby consumption. The Writer, a Management Economist, is Associate Professor, NERIM, Guwahati and visiting faculty, Department of Business Administration, Gauhati University, Guwahati, India. He can be reached at e-mail: m.bibhas@gmail.com