Revenue-oriented policies need to be reviewed to fight inflation

The strengthening of the US dollar by around 12 per cent in the past six months to record levels in recent decades has caused the currencies of most other countries, barring major com­m­odity exporters, to depreciate vis-à-vis the US dollar. That, in turn, is fueling inflation in most countries dependent on imports, especially of fuel, food, and fertilisers.

The responses of various countries are different but many of them have resorted to fiscal and monetary measures to make money more expensive and scarce. In the process, the risks of decreased demand, lower capacity utilization and private investment and consequently lower growth rates have risen across the globe.

In theory, a weaker currency should help exports and discourage imports. However, when the external demand is tepid and currencies of competing economies also weaken, the gains on the export front may not be substantial, except in the case of labour-intensive and high-value additional goods that continue to be in demand despite falling living standards. Imports can moderate in those goods that are sensitive to prices but not in the case of goods whose demand is less elastic. Domestic producers in some countries can get higher prices for their produce when imports get more expensive. However, the producers whose cash inflows are predominantly in local currency and depend on imports for their inputs can see erosion in their margins. A depreciating currency can make servicing debts in foreign currencies expensive for some business entities and countries, especially those that have relatively lesser inflows from foreign sources. 

The Reserve Bank of India (RBI) has taken some measures to encourage foreign currency inflows from non-resident Indians and through external commercial borrowings. However, the effects of these measures on exchange rates are likely to be marginal. The RBI has been intervening in the foreign exchange markets to temper excessive volatility by selling US dollars and in the process sucking out the excess liquidity in the system. As an anti-inflationary measure, this has now worked by allowing the Indian rupee to depreciate less than the currencies of the competing economies but in the coming days, the effect may be to depress domestic demand and prices.

The government has played its part in combating inflation by imposing export duty on steel, taxing windfall profits on some fuel and petroleum products, cutting import duty on edible oils and some key inputs, curbing export of wheat and sugar, reducing excise duties on petrol and diesel, and allowing sourcing of crude oil from Russia at discounted prices and so on.

The depreciating rupee, increase in import duties on gold, and removal of exemption of Integrated Goods and Services Tax (IGST) on imports for certain purposes contribute more revenues to the government. The recent increase in the Goods and Services Tax (GST) rates on many daily use items also boosts coffers of the government, although it has the effect of leaving less money in the hands of people for discretionary spending.

The Russian invasion of Ukraine and the consequent food, fertilisers and fuel supply disruptions and the rupee depreciation due to the strengthening of the dollar in anticipation of rise in interest rates in the United States have contributed to inflation in India.

However, the government can review its excessive revenue-oriented policies to tackle inflation and boost domestic demand. 

email:tncrajagopalan@gmail.com