Kahani Inflation Ki
Authored Article by Sanjay Dangi
Why is inflation so high everywhere? That’s a question that middle-class people worldwide have been asking, particularly the middle-class problem. Unlike the rich or the poor, middle-class people are often salaried, which means that incomes are fixed in the country’s currency, whereas their expenses fluctuate as per inflation rates. This makes inflation their number one obsession. You and I belong to that class, so that will be my article.
In countries where the middle class makes up the bulk of the population, like in the US, the UK, and the EU, inflation is the main topic of public discourse. The US midterm elections and the UK prime ministerial elections both revolve around the issue of inflation at the top. In countries like India, inflation is also a political hot potato, and many of us are concerned about the situation in our neighbouring countries, Pakistan, Sri Lanka, and Bangladesh.
So why is inflation so high in 2022? There are some interesting reasons for it, chief among them are the lockdowns caused by the pandemic, which have suppressed the production of goods in many countries. Unfortunately (in some ways), China’s ‘zero covid’ policy means several lockdowns continue. As China is the factory of the world, lockdowns there have seriously impacted supply chains that ship goods from China’s ports to the rest of the world. Also, add the severe heat wave and other effects of climate change that have caused droughts in Europe and other parts of the world, affecting agriculture and industry. Russia’s rather unhelpful war in Ukraine has also contributed, as wheat and sunflower oil prices have shot up. Other constraints include the short supply of palm oil from Indonesia, the shortage of many minerals from South America, etc. Added to that, there is a gigantic shortage of containers because the shipping lines are clogged with ships queued for miles outside ports, which means that even if production can be ramped up, supply will remain limited for at least several coming months.
Some days ago, I was asked to give a quote about inflation in the UK. While preparing my answer, I contrasted the two candidates’ approaches, Liz Truss and Rishi Sunak. Liz Truss promises to reduce taxes and immediately push cash into the hands of millions of Britons. Rishi Sunak, on the other hand, argues that doing so will mean there is even more cash supply in the economy when goods are in short supply. This means prices will go up, and the spending power given to families will evaporate very quickly.
Instead, he proposes to keep taxes and interest rates high and suck out cash from the system. This will call prices to cool, as not too many people will buy goods and services. Sunak’s is the classical response to inflation, usually caused by an oversupply of cash. Typically, this happens when a country has printed too much money to pay off external debt or has cut taxes, putting more cash in the hands of the people.
The latter is the leading cause of inflation in Sri Lanka, coupled with external factors. Tax cuts caused the prices of things to go up but reduced the government’s reserves. As Sri Lanka depends on imports for most of its goods, inflation skyrocketed once the reserves ran low (of course, I am simplifying). Sunak is arguing that Liz Truss’ policies will lead to the Sri Lanka-ization of Britain (my words, not his).
But is sucking out cash the answer if millions of your countrypeople are struggling to meet their daily needs — some are having to decide between food and medicines. Can you suggest that they should cut down even further? Will it be politically viable to suggest that people not be given financial assistance for a crisis, not their making?
The 2022 inflationary crisis is unique in the recent history of inflation because it is caused by a lack of supply rather than a rise in demand. Crises caused by cutting taxes or printing money can be reversed by raising taxes or “demonetization.” All they are doing is suppressing excess demand. But this is a crisis of regular demand — medicines, daily food (not fancy stuff), baby formula. And it can be met only by improving supply. Where that is happening, prices have begun to fall, gasoline in the USA, for example.
Sadly, this is going to take time to solve. Countries will have to try and improve shipping lines, speed up clearance of ships at ports, and speed up transport from ports to the hinterland. This will need infrastructure building and support for labour. Otherwise, you will likely see more of the strikes that crippled Europe’s shipping and aviation this summer. Further, there will probably have to be government intervention in the form of tax cuts that allow people more spending power while also taking the bitter pill of placing price caps until supply can be restored to normal levels. Ultimately, manufacturing will have to shift back home, what I will call localization so that a future supply chain disruption is not so destructive. Whatever countries think is in their strategic interest, they should aim to bring that back, for example, the CHIPS Act in the USA.
All of these are long-term solutions, which means that, for the time being, there is going to be pain. There will be impoverishment and serious consequences for not just internal politics but international affairs as well. What does this bode for India?
Nothing much. India has escaped much of this trouble because, for one reason, it has not integrated into the global supply chain as much as many other countries have. It is largely self-sufficient in many food items, and its fuel bill is fairly controlled. Secondly, it has raised taxes by bringing many goods and services under GST. I know this is not a very popular move for any democratically elected government, but it has been a wise move economically. Thirdly, the RBI has gigantic reserves of foreign exchange. So even if there is an increased outgo, it is well-cushioned. It is also raising interest rates which, combined with tax rises, helps tamp down demand (although such a double whammy is probably not all too wise, given that the economy needs to proliferate to get out of its covid and pre-covid slump). Fourthly, by buying oil cheap from Russia, India has managed to keep its import bill low, even though that is a very unpopular move with the West.
All of these together make sure that the India story will remain robust with low inflation and high growth story for the coming future when the world is veering from crisis to crisis.