Global wheat prices are $389 per tonne as against $209 a year ago. Rice prices have almost tripled in comparison to last year. Oil is at $120 a barrel as against $68 a year ago. Inflation in India is now 7.54 per cent as against 6.34 per cent a year ago. High price rises this year on top of similar increases in the previous year indicate that the prices of these and other essential commodities have reached unaffordable levels. This will dampen consumption and hence growth.
More importantly, its impact on vulnerable sections of the population will be quite severe. But the response to this serious threat has been half-hearted, such as banning exports, tinkering with duties, sabre rattling against hoarders and alleging producers' cartel, raising CRR and so on. These apart, there is no holistic policy response, leaving one wondering why we are so sanguine and when should we really panic?
Agreed buoyant economic growth, with a resultant increase in per capita income somewhat buffers the effect of these price increases. Also, this inflation level is considerably understated, with oil prices not having been passed through and food prices benefiting from restricted market exposure. These factors may have suppressed the extent of the real danger that the underlying pressure of price rise can pierce through the flimsy cover provided by administrative measures. In some fast growing countries like Vietnam, inflation has touched 20 per cent for precisely the same reason as in India. These prices have risen due to inadequate supply, while demand has been rising in proportion to increasing wealth and economic growth.
The RBI's monetary policies will have a limited role to play in this problem of the supply-demand gap. Raising interest rates in such a scenario would have dampened capacity expansion plans which are so critical for improving the supply situation and moderating inflation in times to come, without dousing inflation in the present time. A moderate tightening action of raising the CRR to suck out excess liquidity was an appropriate step to keep inflationary pressures from excess liquidity at bay, which the RBI has done. There is nothing more that the RBI can do. The government's efforts to ease supply constraints are in the right direction. However, supply responses are likely to be time-lagged, exposing the economy, especially the weaker sections vulnerable to disrupted growth and starvation.
The vulnerable sections of the population have been insulated from the growth upside and spend a much larger proportion of their incomes on food and fuel. NSS data shows that the lowest decile of the population allocates around 65 per cent of its consumption expenditure to food as against 23 per cent by the top decile. With over 22 per cent of the population below the poverty line and a large section at the margin, safety nets are needed even during normal times. They are absolutely indispensable in times of high inflation fired by food prices.
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Merely increasing the subsidy without fixing leakages in the public distribution system will raise the fiscal deficit without being effective. An overhaul of the public distribution system is required to reduce the subsidy bill and still be more effective. The Raghuram Rajan committee's suggestion of ensuring every recipient of government subsidy and subvention has a bank account, connected to the mainstream, into which these amounts should be paid, is a good way of ensuring that the money gets to the people to who it is intended.
This situation, therefore, calls for a holistic response, including on the demand side while waiting for supply-side response to catch up. A full-scale frontal attack on the demand side including rationing, cess on high consumption and moderation on excessive consumption behaviour should be initiated.
Let us take the case of oil. Indian data clearly shows that the intensity of oil use per unit of GDP (measured as barrels of crude oil per unit of GDP) has remained stagnant in the last three years despite a sharp increase in crude oil prices. Many other countries including the US are using less crude per unit of GDP. Also we have not passed on the global crude price increases to the domestic economy, thereby negating any prudence in the use of oil in the economy. The suppression of domestic oil prices might stem inflation in the short run, but it will cripple the oil companies, their expansion plans, stretch government finances, and expose the economy to higher inflationary pressures.
Demand-side management in oil is thus an imperative now and should be initiated on a war footing. Traffic restrictions, mild rationing of oil coupled with cess on use for non-essential needs, and partial passthrough of oil prices to the general population along with targeted subsidy for the weaker consumers will help moderate demand. Similarly, food consumption rationing, cess on excess consumption, penalties on wastages and incentives for increasing productivity, not only in farming but also in the supply chain, are required.
These suggestions are clearly against the free market doctrine that our national policies have favoured, and with which I fully concur. There is also the risk of the undesirable development of a black market whenever rationing or selective taxing or targeted subsidies are administered. However, the slow supply-side response, not just in India but all over the world, in not investing enough in real sector essential commodities such as food and fuel is a cause of grave concern at this time.
The nation must guard against this global phenomenon, with measures designed to ease the pressure for the time being, till normalcy is restored. Some measures such as the fight against wasteful and excessive consumption are good long-term behaviour-altering measures which should be entrenched. The imposition of punitive taxes and workable incentives to curb such practices is a good starting point.
Undoubtedly, high taxes are market-distorting measures and should be done away with once the desired pattern of behaviour is evident, with workable incentives being in place to sustain the gains obtained from such measures. Traffic restrictions could be relaxed once a viable and meaningful public transport mechanism is in place. Targeting subsidies is a legitimate long-term goal in its own right, but has become an imperative under these dire circumstances. Surely, only long-term measures aimed at improving supply will yield sustained benefits and relief from high prices. But till then, it is prudent to curb excessive and wasteful demand.
The author is the Managing Director & Regional Head of Standard & Poor's, South & South East Asia. The views expressed in this article are personal. He can be contacted at r_ravimohan@standardandpoors.com