Saturday, May 24, 2008

Bush and inflation

Many pple were making fun of what Bush said a few weeks ago about the increase in income levels of middle class pple in India and China to be a major reason for inflation, infact i was one among those pple too. On a rethink i may possibly be wrong in my estimation, there is another school of thought who make sense in what bush said. When bush said that pple in India and China had started to consume more, it doesnt mean that we all had started to eat more (which is a blatant form of taking it), it means that the affluence levels of a majority or lets say a portion of pple in both countries has gone up. When that happens the supplier will know that u will pay more for the same commodity and hence charges u more. Well, there can be more than one definition of demand, first one is when pple have started to ask for more quantity and the other is when pple are ready to pay more for the same quantity, we may probably be experiencing the second one.

Various commodities of food are generally inelastic which means that significant increase in price does not bring about a decrease in demand. When thats the case, the supplier will keep testing the sensitivity levels of the consumer by increasing the prices untill a point where he feels that pple have become real sensitive i.e a point where the commodity becomes elastic. Between these two levels i.e the insensitive and sensitive level, the prices would mostly skyrocket.

However, an increase in affluence levels of pple alone may not be the only reason for inflation. In an country like India who happen to be net importer, our annual fiscal deficit for 2007-08
is around $80bn even if we remove importing oil out of the equation we would still be $3bn in deficit which says that we are a net importer and we have always been importing wheat and other essential commodities in the past to satiate our local demand. That being the case, there has been a shortage of food production, world over for the current year which adds to the supply side inflation. When it comes to food, what we have is a world food market, something that affects other countries affects us also. Hence to an extent, we can say that, the inflation that we have now to be an imported inflation.

Ofcourse this is a definite demand-supply mismatch but the good news is that famers will start to produce more wheat, rice and other essential commodities and that should satiate the demand and possibly bring down the price. As per the recent study, the farmers in Afghanistan have switched from growing opium to wheat owing to greater price for wheat. Isnt that good news ??

Now, the only reliable and sensible way to mitigate the increasing food prices when the economy is booming is not by banning exports or putting a cap on price but to use the futures market and hedge yourself from increasing price rise akin to what the IT organisations does to protect itself against decreasing $ value.

Hope the govt. listening :)