India’s Tryst with Consumer Price Inflation

Mr. Sanjay Dangi, Director – Authum Investment and Infrastructure Ltd., & Financial investor to many startups.

The 1974 film Roti, Kapda aur Makaan had a song that went blockbuster:

शक्कर में ये आटे की मिलाई मार गई, पाउडर वाले दूध दी मलाई मार गई,
राशन वाले लैन की लम्बाई मार गई, जनता जो चीखी, चिल्लाई मार गई,
बाक़ी कुछ बचया महँगाई मार गई, महँगाई मार गई, महँगाई मार गई…

For those of my readers who lived through the early 1970s, this song will resonate. It was a time when inflation had crossed 28%, causing severe shortages of essential items at ration shops. This was a time when the government rather than the market fixed the prices of items, causing them to be diverted to the black market. There was also rampant adulteration, because it was uneconomical to sell goods at the designated prices. It led to public disenchantment with the government, and the turmoil it created in the nation would lead to Emergency in June 1975.

Most economists will tell you that inflation is good for the economy. It allows people to get better prices for their produce, and they in turn spend more on other goods raising demand. In other words, inflation fuels growth. On the other hand, most central bankers try to keep it under control – it erodes the value of the currency and people’s assets. That’s why beating inflation is one of the goals of a sound investment strategy. However, inflation is a lot more complex than that.

Firstly, there are many ways of measuring inflation. What we call inflation generally – because it affects us directly – is consumer price inflation, also known as headline inflation. This includes food and fuel prices, which tend to be more volatile than other goods (such as say metals or cars or consumer durables) – and which the people notice first. They may be temporary, but have strong political consequences.

After independence, India finally had a government and central bank that was interested in managing headline inflation (unlike its colonial predecessor). In the 1950s, inflation remained largely under control – though it took its toll on GDP growth. In fact, there were even deflationary trends in 1952-3, because of a bumper crop. There were more goods in the market than money, causing prices to fall steeply and impoverishing farmers. Ask the Japanese – their economy imploded in the 1990s and 2000s leading to the ‘lost decade’ of stagnation and deflation. People put off purchases in expectation of better prices, which in turn caused stocks to build up, production to be curtailed and prices to be slashed further in the hope that people would buy. Luckily India recovered from its deflation quickly.

Two wars in the 1960s followed by two famines caused food prices to skyrocket, and India experienced more than 12% inflation for the first time. Food shortages were so severe that the then prime minister, Lal Bahadur Shastri, advocated (and practised) eating only one meal a day. The Green Revolution and abundant rains cooled the inflation till the ‘Oil Shock’ of 1973. Arab nations cut production by 25% to protest Western support to Israel in the Yom Kippur War. As oil prices skyrocketed by 250%, it triggered a global recession. In a country as severely dependent on oil imports as India, foreign reserves plummeted, leaving the government no leeway to subsidize fuel. When fuel prices rise, food prices rise. The middle class complains and governments panic (everywhere in the world). This was not growth-friendly inflation, but the opposite.

However, the easing of crude prices led to a sharp drop and caused a small period of deflation. This in turn put pressure on the government’s debts. India did what many governments have done before – print more currency to pay its debtors. But more currency in the market has a tendency to drive up inflation, because the real value of the currency against other goods drops. So, in the 1980s, inflation often crossed 10%. But GDP growth remained anaemic, as most market-unfriendly policies remained in place, such as the production curbs and the license-inspector raj, severe controls on foreign exchange, a fixed exchange rate and price controls.

However, all that only caused India’s external debt to go up, until the humiliating spectacle of India having to pledge its gold reserves as the government ran out of cash. It finally bit the bullet and implemented the reforms of 1991, floating the currency and ending production curbs. The pent-up demand soared, production went into overdrive, and inflation touched nearly 15% at one time. But this was in an economy that was heating very quickly. In the decades following, inflation has remained relatively low, though well above those of developed countries.

The middle class would love a situation in which its income goes up in glowing annual appraisals while prices remain stagnant. But inflation is nobody’s baby. As we have seen in India’s history, it can be high when growth is low (1970s and 80s), low when growth is also low (1950s), high when growth is high (1990s). The ideal situation of high growth and low inflation needs a lot of things to fall together at the same time – the monsoons and OPEC behaving themselves (so no food shortages and low oil prices), growth in production being able to keep pace with growing demand, and no bubbles bursting causing deflation. Most importantly, no whimsical changes in policy setting back the economy, like Mao’s ‘War on Sparrows’ that decimated Chinese agriculture in the 1950s. With all this in mind, India had a lucky period from 1999 to 2008, when the Global Recession upset the applecart.

Whenever inflation makes the headlines, do consider the causes. Firstly, it is most likely that your attention is focussed on food and fuel, i.e., headline inflation. These prices are slaves to fate, chance, kings, and desperate men as Shakespeare put it. Prices fall as fast as they rise – but you barely hear anyone talking of falling prices. You may feel the pain when tomatoes are expensive, but you can sadly not stock a fridge full of them when they are cheap. There’s no choice but to bear the inflation. Look at the prices of other things – white goods, or commodities like steel. Have they gone up significantly?

Secondly, did you gain from it? If you are part of the salaried middle class, obviously you wouldn’t have – for there is no boss that will raise (or cut) salaries based on the monthly inflation rate. But if you are a maker of goods or a vegetable seller – you might see a rise in income and be pleased about it. If your investments are diversified enough, you may see the value of deposits erode, but be compensated by the rising values of stocks of companies whose profits are rising.

If you are an innovator, you may have reason to be happy. People are open to trying new technology if it promises to cut their electricity bills (LED lights), reduce food wastage (refrigerators) and other things that bring expenses down. An ideal, free market will allocate more money to these innovators. So, inflation helps a society grow and innovate, by allocating resources optimally.

Inflation is the only way incomes will ever rise (and rarely do people want a cut in salary). High prices force employers to pay more in wages at the risk of strikes. These wages are immediately spent in the market for Roti, Kapda aur Makaan, channelling cash through the entire economy. Therefore, governments sometimes pump cash into the economy – what is called a Keynesian stimulus. The next time you make jokes about oil being costlier than alcohol, do remember that one way to control it is for bosses collectively to give their employees no raise at their next appraisal. Or to cut salaries to limit spending power, triggering a deflationary spiral and wiping out growth.

The last is an external cause such as an oil shock, or a fundamental misbalance, such as Germany’s war reparations after World War I. At the Peace of Versailles, the defeated Germany had its industrial production curtailed and was forced to pay a gigantic fine (known as reparations) for ‘starting’ the war. Its industrial exports were not enough to pay for the reparations, finally forcing the government to print currency in the 1920s, just as India did in the 1980s. It printed too much, making a joke of the reparations – but the currency became worthless, and inflation reached 29,500% in October 1923. Although the hyperinflation was controlled, the political turmoil led to the rise of fascism and the Nazi party, which called for an end to reparations and violation of the Versailles agreements.

The moral of this history is that inflation will always be there. Tomorrow, if not today. What can one do to keep inflation from eating one’s lunch? Diversifying investments is the way. As you near retirement, you want stabler funds, so it is natural that you will want to have investments with fewer risks, which give you a consistent income to meet daily expenses and medical needs. It’s when you are young, have more physical energy and risk appetite, that there is the opportunity to beat inflation over a lifetime. This is when you can invest more in stocks and mutual funds (with some in fixed deposits and government bonds), so that over the years, you build up a tidy pile, which can tolerate some erosion in value due to inflation.