Good news at last Inflation has followed the trend

Remember the good old days when it was believed, and correctly, that the domestic rate of inflation, given Nepal’s exchange rate system and open border with free flow of goods and services, is determined and equal to the rate of inflation in India, the country’s main trading partner. The rate of inflation in India is declining so much so that in the absence of proper policy measures it may experience a deflationary trend. The experiences of other Asian countries are not different either. In an article published on February 26, the has appropriately summarized the current situation. It said “Inflationary pressures, which in the middle of 2008, were viewed as the biggest threat to Asia’s growth prospects, have ceased tremendously…. However, with inflation falling rapidly in so many countries, deflation is emerging as a threat.”

In Nepal, it is claimed by many that the situation is completely different, though there has been no change in the trade and exchange rate system with India or any country. A recent report of WFP, according to press reports, states that “Nepal’s inflation rate, instead of following the Indian rate, is going up and more than double the target of 7 percent set by the budget. It stands at 14.4 percent by the end of first six months of the current fiscal year.” Both the

fiscal and monetary authorities of the country too have given the impression

that the domestic rate of inflation has remained relatively high, and may continue to remain so in the coming weeks and months. The Nepal Rastra Bank, the central bank, has informed the government that the current inflation is due to non-monetary factors and, according to press reports, has asked the government to control it, which, in turn, is planning to open fair price shops in various parts of the country.

The basic question that has emerged now is simple: Why is Nepal, as is believed even by the policymakers, suddenly experiencing a situation on the price front different from that of its main trading partner and other Asian countries? I guess no economic theory developed until now can explain the existing situation claimed to be Nepal’s unique experience. As a result, the government is not following correct policies. The experiences of various countries show that it is virtually impossible to control the rate of inflation, defined as a continuous rise in the price level or fall in the value of money, through direct control measures. I believe inflation is always, and everywhere, a monetary phenomenon, a theory that no one has dared to challenge until now. The NRB, of course, has indicated its inability to control price through monetary means. We are now facing a unique situation, and, therefore, are in need of detailed analysis, first, to understand the existing inflationary situation, and, second, to develop appropriate measures to control high price.

The price level in the first six months of the current fiscal year did not increase by 14.3 percent, as claimed in the WFP report; but it increased by about 5.0 percent. In fact, the price increased at a very high rate in the first two months following the election to the Constituent Assembly. This is due to several factors, both domestic and external, including political uncertainty, increase in the price of oil and oil products and rise in the inflation rate in India. In fact, in the month of mid-July/August, the country experienced almost hyper inflation with the overall price index increasing at an annual rate of 51 percent and that of food and beverages by 66 percent, according to data published by the Nepal Rastra Bank. As a result, the price level of several commodities, specially food and beverages, reached a relatively high level and has not come down yet.

The rate of inflation, though still high, started to slow down, and in the month of mid-October- November, 2008, the overall price index rose at an annual rate of about 3.0 percent, almost equal to the rate experienced by India. The country may experience a deflationary trend as any other Asian country as predicted by The Economist. For example, in the month of mid- ovember/December, 2008, the overall price index, due partly to the decline in the price of food and beverages, decreased at an annual rate of 22 percent. It is doubtful whether the same trend will continue in the coming months, but it is sufficient to indicate that inflation, that is, price rise, is not a major problem in the country now.

The rate of inflation that the country has experienced until recently, however, has pushed the prices of various goods to a relatively high level. It has affected the standard of living of the people with fixed income. The recent decline in the rate of inflation simply indicates that the problem associated with price increase or inflation is under control. But the problem of high price is still there. We need detailed programmes to help the people with fixed income. It needs active participation from both fiscal and monetary authorities.

Dr. Pant is associated with the Institute for Development Studies