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India’s high inflation supports food prices and potash but negative outlook remains

India's Inflation Rate 2013-05-07Enlarge GraphWhat is inflation?

The inflation rate is the rate at which a price is rising, usually on a year-over-year basis. High inflation rates reflect shortages of supply relative to quantity demand. Thus, rising rates indicate higher demand or lower supply. While rising rates often suggest positive economic growth, experts view a substantially high inflation rate as negative because it could lead to hyperinflation (very high, seemingly unstoppable inflation) or a sharp economic slow down.

India’s food inflation rate lowers disposable income

While India’s wholesale price index fell to 5.91% in March this year, its consumer price index remained well above 10% in February, driven by poor food and supply chain management and higher demand rather than supply issues. This is troublesome for the developing country, which relies heavily on private consumption, as it lowers disposable income. This is especially dangerous since food makes up about 50% of India’s household expenditure, according to Moody’s, which recently gave a negative view on the country’s debt rating.

According to Moody’s, increasing food supply could lower inflation. This result could be achieved through increased use of potash, a fertilizer that’s been under-applied lately due to favorable government policies toward nitrogenous fertilizers. Yet, given the weak currency and the recent announcement of a subsidy cut for potash, a dramatic rise in potash demand and food supply is unlikely. As long as food inflation remains high, India will continue to face a weak economy—despite the fact that the International Monetary Fund (IMF) recently upgraded its outlook for India based on improving global economic outlook and falling wholesale prices.

High inflation could further weaken the rupee

Persistently high inflation will harm India’s fiscal deficit and the country’s economy, potentially weakening the rupee even further. This is especially true if India does not fix its food infrastructure. A weaker rupee will make potash much more expensive for farmers, which will have a negative consequence on food supply in the future. Although it’s inevitable for India to postpone potash application indefinitely, risk remains in the meantime. While increased imports from China may lift companies such as Potash Corp. (POT), Agrium Inc. (AGU) and Mosaic Co. (MOS), sustained low demand from India will negatively affect the upside.