Are we doing enough to control inflation?

DEBATE

New Delhi

With a bit of imagination one can picture the view of the economy from the highest perches in government to be a bit like that in a process control room of a chemicals plant.

The blinking lights, flickering dials and dancing columns on bar charts, reporting data from a host of transducers, constantly update the operator of the state of the process. When the information doesn't quite add up, the controls are used to stabilise the process.

The only difference is that in an industrial process control room the information is real-time, while in government information is invariably dated when available and often inaccurate. To compound matters, governments have few knobs to turn and buttons to push.

And of what few there are, many don't work. Yet like King Canute, prime ministers and finance ministers persist in attempting to turn back the ebbs and tides of the economy.

This reminds one of Harry Truman's remarks on the eve of General Dwight Eisenhower's inauguration. "He'll sit here and he'll say, 'do this, do that!' And nothing will happen. Poor Ike "" it won't be a bit like the Army. He'll find it very frustrating."

Prodded by reports of the weekly wholesale price index (WPI) rising sharply, the prime minister has been issuing orders. Like Eisenhower, Manmohan Singh, too, will realise that in real life things don't work as predictably as econometric models.

It's possible that Singh realises this, but is playing the game the way it is traditionally played "" with a little bit of play-acting and grand-standing. The WPI has been rising since the middle of last year, mainly because of the rise in the world prices of commodities like steel, cement and oil. There is little the government can do to control these.

Steel is a typical cyclical business. A few years ago, world prices were about half what they are now. Consumers loved it. The industry took a huge beating and little additional investment was made.

The result is that today when demand is surging, supply is lagging. So prices will inevitably go up. Only a latter-day King Canute will try to roll them back. Singh might have a little more luck with cement, but not enough to make an impact.

But he will have no luck at all when it comes to oil prices. Both President Bush and Putin love high oil prices. India imports almost 70 per cent of its oil and this will only keep growing.

The demand for petroleum products is not sensitive to prices, and the government has a major addiction to petroleum imports because it provides the coffers with the biggest single source of revenue "" over Rs 1,10, 000 crore last year.

Oil prices are now lapping the $ 50 a barrel level, and in private, Chidambaram must be loving this because for every $ 1 rise in oil prices the exchequer stands to gain over Rs 1,500 crore by way of additional taxes and duties.

But the rise in the WPI gives the present government a good stick to beat the previous government's record and the noisy concern about it should also been seen in this light.

I would not have minded if the government's concerns were limited to noises. But the government has backed up its "concerns" with some executive actions. It has cut the import duties of steel and oil. This might result in a revenue loss of about Rs 4,000 crore.

Singh, Chidambaram, Mani Shankar Aiyar and Ramvilas Paswan seem mighty pleased with their efforts. I can understand if Aiyar and Paswan are pleased, for it is well known that they are yet to grow out of their ideological adolescence, but the first two should know better.

Every rupee the government gives away by foregoing revenue is at the cost of the poorest of the poor since it is only capital expenditure that gets slashed.

The government should be more pre-occupied with the monthly consumer price index (CPI). But the CPI has behaved quite well despite the recent flare-up of vegetable prices.

And if they keep rising there is little the government can do. It can hardly take recourse to importing bhindi and baingan. It can tinker with sugar prices, but with elections around the corner in UP and Maharashtra that is not a plausible option. So is the government doing enough to curb inflation? It has cost poor the people of India Rs 4,000 crore and that is quite enough.

Managing the economy is not the same as conducting an economics seminar.

Mahesh C Purohit
Director, Foundation for Public Economics and Policy Research,
New Delhi

The United Progressive Alliance (UPA) government inherited a sound economy with stable prices and a high volume of foreign exchange reserves. Today, the economic scenario has changed. The new government is facing the menace of spiralling prices that will affect future growth prospects of the overall economy.

Global oil prices have shot up to a record 22-year high and this has forced the government to increase fuel prices twice since June. Also, an erratic monsoon contributed to the general price rise. Both these factors are beyond the control of the government which is now confronted with an annual rate of inflation of 8 per cent.

A break-up of the wholesale price index (WPI) indicates that the maximum increase of 1.5 per cent was in the fuel, power, light and lubricant sector. This increase was on account of an increase in the prices of petroleum products announced on July 31.

This has led to an increase in prices of aviation turbine fuel (ATF) by 11 per cent, light diesel oil by 9 per cent, naptha and high-speed diesel by 5 per cent, furnace oil by 4 per cent and petrol by 2 per cent. The cascading effect of the price increase in this sector will be more visible in the future.

The indices for primary articles and manufacturing sector increased by 0.1 per cent. In the primary articles segment, the index for food articles rose by 0.2 per cent due to higher prices of poultry chicken (3 per cent), and fruit and vegetables (1 per cent).

In the manufacturing sector, the index for basic metals alloys and metals products recorded a rise of 0.6 per cent. The increase was due to higher prices of bolts and nuts (10 per cent), steel ingots (8 per cent), angles, channels and sections and aluminium foils (1 per cent). Given the spiralling prices, the government should be more concerned about the hike in prices of manufactured items than in the price rise of the fuel, light and lubricant sector. The government has to prevent the economy from getting entrapped in a cost-push and demand-pull situation.

As was recently announced by Prime Minister Manmohan Singh, the government has already swung into action and taken various fiscal measures. It reduced customs duties on petroleum products by 5 per cent and excise duty by 3 per cent. It also intends to reduce customs duty on non-alloy from 10 to 5 per cent; on ship-breaking from 15 to 5 per cent, on scrap used for making iron and steel from 5 to zero per cent. The countervailing duty (CVD) exemption has now been withdrawn on such ships. The general perception is that it is the bickering within the ruling alliance that has prevented this government from taking the necessary steps well in time. Primarily, it must adopt measures that have long-term implications.

Apart from reviewing public expenditure management so as to reduce wasteful expenditure, it has to adopt measures to improve infrastructure and supply management. More importantly, the overall tax policy needs to be reviewed again, encompassing central taxation as well as state taxation of the entire petroleum sector.

The existing sales tax system also needs a thorough review. It is important to consider changing the method of levying tax on this sector from ad valorem to specific rates, both under central and state taxes.

In the context of the reduction of duty on items of steel and aluminium, a stable tax policy is needed to encourage investment in any sector. There is a need to review the tax system that has introduced a duty revision for the fourth time since January, bringing down the effective duty from 30.8 to 5 per cent.

In spite of comfortable food stocks, the government has done nothing to spell out a well-designed public distribution system (PDS) to curb price rise in vegetables, fruits and agricultural produce.

The hike in the rate of service tax and its extension to many services in the recent Budget without bringing the tax into a value-added tax regime is bound to have an inflationary impact.

Finally, the monetary policy has not been proactive. The focus of the Reserve Bank of India (RBI) has so far been on neutralising the impact of increasing foreign direct investment.

The government has taken recourse of the market stabilisation scheme and through the issue of dated securities and treasury bill managed to mop up a total sum of Rs 77,000 crore during the last two quarters, resulting in a significant amount of negative borrowing by the government.

This time, the borrowings by the government from the RBI have not contributed to the inflationary trend, unlike earlier years. The time has now come to use other instruments of monetary policy to check the spiralling prices.