Inflationary pressures in South Asia

The similarities yet differences across South Asian countries, and their differential response to recent food and oil price shocks, provides a useful opportunity to better understand the structure of inflation in these economies. Analysis of the internal goods market and external balance of payments equilibrium and evidence on demand and supply shocks suggests that output is largely demand determined but inefficiencies on the supply side perpetuate inflation. Pro-cyclical policy amplifies the negative impact of supply shocks on output. Inflation surges are reduced at high output cost while propagation mechanisms and well-intentioned administrative interventions turn relative price shocks into chronic cost-push inflation. The analysis brings out the importance of food prices for the inflationary process. It is necessary to protect the poor from inflation and especially food inflation. But this must be done effectively. The paper concludes with an analysis of effective short- and long-run policy options.