The inflation monster

The incumbent regime is jittery. Accusations and counter-accusations are being hurled by important ministers in the government against one another. Within the Congress party, which leads the ruling United Progressive Alliance coalition, a blame game has begun. Who is to be held responsible? Fingers are being pointed at Prime Minister Manmohan Singh and Finance Minister Palaniappan Chidambaram. And the reason is obvious. Prices of food products have been rising at a pace that is politically rather too uncomfortable in an election year. The monster of inflation threatens to gobble up all the gains claimed by the UPA government over the nearly-four years it has been in power.

That inflation could go out of hand was feared by many. Still, those in government were keeping their fingers crossed hoping that the situation would not go out of hand. But it has. Not only have food prices risen at an alarmingly fast pace, there is apprehension that the inflation rate may pick up further if the monsoon is not favourable. If Indra Bhagwan, the god of rainfall, does not smile on the country, hyper-inflation cannot be ruled out. That may or may not happen, but the position is pretty bad in any case.

At a media conference on March 31, Congress party spokesperson Veerappa Moily reeled of statistics on inflation in other countries. He pointed out that the inflation rate was around 8.4 per cent in China at present against barely 2 per cent recently. Moily wanted to underscore the point that inflation, especially the rise in prices of food products, was a global phenomenon and not confined to India alone. He did not, of course, mention that there have occasions not very long ago when the annual rate of inflation in countries like Brazil, Argentina, Russia and Israel have ruled at triple digits.

Nor did Moily choose to point out that according to the government of Zimbabwe, the annual inflation rate in 2007 was in the region of 16,000 per cent! In other words, prices had jumped 160 times in that African country bringing it back to an era of barter exchange, somewhat reminiscent of what had happened in the Weimar Republic in Germany in the 1930s. These examples mean nothing to the person on the street, the proverbial aam admi. The home-maker knows how her budget has been squeezed and she certainly does not go by the figures put out by the Indian government, which releases data on the wholesale price index every Friday. (See accompanying story on why official price indices do not reflect the reality on the ground.)

World food prices have never been as high as they are currently, making the import option rather expensive. Thus, even if foreign exchange reserves with the Reserve Bank of India are at a record level in excess of US $ 280 billion, the problem that has been witnessed over the last two years continues, namely, world food prices shoot up as soon as India announces its intention to buy. This has been particularly true in the case of wheat. We, therefore, have a piquant situation in which the government of India pays farmers a minimum support price of, say, Rs 1,100 for a quintal (100 kilograms) of wheat and also ends of importing inferior quality wheat from a country like Australia at a landed price that is higher by Rs 600-800 a quintal.

An important challenge before Union Minister Sharad Pawar has been his ability to balance the interests of farmers and consumers. After all, he is both Minister for Agriculture as well as Minister for Consumer Affairs. This particular balancing act is not an easy task at the best of times – it is tougher than managing cricket in the country. Sugarcane farmers in Maharashtra may be grateful to the Pawar and the government for the loan waiver scheme. But the rest of India may not be as appreciative. The bigwig of the Nationalist Congress Party is one of the ministers who has been attacked for allegedly mismanaging food supplies, even though he has staunchly justified his actions at Cabinet meetings.

Many believe that the haphazard way in which the country has exported food products (in particular, dal, and also rice and wheat to an extent) over the recent past, has been less than prudent. One example would suffice: in the course of calendar 2006, exports of onions surged by over 60 per cent while retail prices at home shot up by around 150 per cent. Successive governments at the Centre and in the states have also not been able to improve the working of the public distribution system in many parts of the country.

The country’s total wheat stocks came down to 2.01 million tonnes in April 2006 from a peak of 41.1 million tonnes in July 2002 (against a buffer norm of 15 million tonnes). Between January 1, 2007 and New Year’s Day this year, wheat stocks had risen from 5.42 million tonnes to 7.71 million tonnes – that are still well below the buffer norm. Six years ago, Nobel laureate Amartya Sen and his collaborator Jean Dreze had pointed out that if all the bags of wheat and rice with the Food Corporation of India were placed end to end, the row of bags of foodgrain would go all the way to the moon and back!

Managing food supplies, calibrating exports and imports and coordinating the activities of at least three important ministries – Agriculture, Commerce and Finance – has not been the government’s only headache in controlling inflationary expectations. The problem in India has been compounded by the skyrocketing international prices of crude oil over which the government has had no control.
Who recalls that when American troops entered Baghdad in March 2003, the price of oil was less than $ 25 a barrel? These prices have since more than quadrupled. The demand for petroleum products in India is growing at least as fast as the speed with which the country’s gross domestic product is expanding, that is, 8-9 per cent per year, if not faster. Because domestic output of crude oil is hardly going up, the country has become, and is increasingly becoming, dependent on imports. India is currently importing three-quarters of its total requirements of crude oil, roughly two-thirds of it from the Middle East (even if supplies are contracted from different parts of the world).
A combination of two broad sets of factors – described by economists as ‘demand-pull’ and ‘cost-push’ factors – contribute to inflation. Till the end of August 2006, inflation was largely cost-push and driven by high oil prices. International prices of crude oil had crashed from over $75 a barrel in early-August to just over $ 50 a barrel by December that year, before going up. During this period, domestic retail prices of petrol and diesel did not go down commensurately. The government wanted to protect its tax revenues and the bottomlines of oil companies. Prices came down much later and only by a small proportion.

Given the present political reality, the government will not be able to again increase the prices of petrol and diesel. Even the modest hike in diesel prices has jacked up transportation costs. In turn, this brings about a more-than-proportionate, across-the-board hike in the retail prices of a host of products of mass consumption, especially food items.

Roughly half the consumer price of both petrol and diesel goes to government coffers. In the budget, Chidambaram changed the structure of excise duties on petrol and diesel by making these specific (that is, the tax is levied on the basis of quantity and not value). However, customs duties remain ad valorem and add to the government’s revenues when import prices go up. North Block is clearly reluctant to give up this source of money on the ground that these funds are needed for the government’s various social welfare schemes. Rather belatedly, the Finance Ministry agreed to cut customs duties on imported crude oil.

An increase in the subsidized prices of kerosene and cooking gas seems most unlikely. Since the government will not risk taking politically ‘hard’ decisions at this juncture, it will issue more bonds to oil refining and marketing companies (like Indian Oil Corporation, Hindustan Petroleum corporation and Bharat Petroleum Corporation) to compensate them partially for what are euphemistically described as ‘under-recoveries’. In the current fiscal year, till the end of February, the government had issued securities worth Rs 1,257 crore to oil companies in lieu of subsidies. India had been cushioned from the worst ravages of the increase in world prices of crude oil because of the recent appreciation in the value of the Indian currency in relation to the US dollar, but even this bit of comfort has disappeared.

Oil prices in international markets show no signs of significantly abating at the time of writing, although at least one reputed international organization (the United Nations Economic and Social Commission for Asia and the Pacific) has gone on record saying it expects oil prices to fall on account of the slowdown in the US economy. The price of the average basket of crude oil imported by India has crossed the $ 100 a barrel mark.

Even if world oil prices come down, it seems unlikely that food prices will. The planet’s energy security and its food security are getting increasingly interlinked as more wheat, maize and soyabean get diverted for the production of biofuels.

If there is one economic phenomenon that affects the lives of everybody and makes politicians in particular very scared about their future, it is inflation. What is worse for India’s rulers at present is the simple fact that inflation has been largely driven by high food prices. Economists point out that inflation is like a tax on the poor -- it results in an indirect transfer of resources from the poor to the rich. Inflation shrinks the real incomes of the underprivileged while the incomes and profits of the affluent rise. When inflation is driven by high food prices, it becomes a double tax on the poor because the poor spend a relatively much higher proportion of their total incomes on food unlike the rich.

Faced with rapid erosion in its popularity, the government is fighting with its back to the wall in trying to control the rise in prices. The problem with both fiscal and monetary measures is that none of these offer instant, quick-fix solutions. The problem of inflation is structural and systemic – it did not occur suddenly, not will it disappear overnight. Many critics of the ruling regime argue that the measures that are currently being taken to control inflation should have been initiated at least two years ago to prevent ‘overheating’ in the economy.

In its desire to crow about the high rates of growth of the economy, the government in general and the Finance Ministry in particular went slow in suggesting to the RBI that the cash reserve ratio of banks be stepped up (thereby reducing money supply). Chidambaram was also hesitant about hardening interest rates because such a move was opposed by corporate captains on the ground that it would slow down industrial growth and the expansion of housing and construction. Today, the FM has no choice but to sing a different tune. He now says the government is willing to sacrifice growth in order to keep prices in check.

Chidambaram has clearly had to succumb to pressure exerted on him by the ‘left’ faction within the Congress, which has opposed the ‘neo-liberal’ and ‘market-friendly’ economic policy stance favoured by him and the PM. The ‘left’ wing has exerted considerable pressure on party president Sonia Gandhi and told her that many of the government’s economic policy positions will prove to be politically disastrous. It is contended by this section that the poor vote in large numbers – unlike the wealthy sections. This group rues that the government has woken up to this aspect of the Indian reality rather late in the day when elections are round the corner.

It may be fine to announce a Rs 60,000-crore farm loan waiver scheme and shout about it to the rest of the world. But controlling prices poses far tougher challenges. The poor does not care if India’s gross domestic product has grown by more than 9 per cent two years in succession for the first time in sixty years. For them, the prices of wheat, rice, dal and sabzi matter.

Over the last year and longer, Prime Minister Manmohan Singh has time and again said that curbing the rise in the prices of essential food products is topmost on the list of the government’s priorities. The question, therefore, is why the government has apparently failed in this crucial task? By arguing that inflation is a global phenomenon, the government may not be able to convince ordinary people to vote for the ruling dispensation.

In the first press conference he addressed as Finance Minister in the P.V. Narasimha Rao government in June 1991, Manmohan Singh had questioned the feasibility of implementing Rajiv Gandhi’s pre-election promise to roll back prices of various products if his party was returned to power. Congress party netas were livid at what the learned economist and technocrat had naively remarked. He perhaps knew, better than most others, how difficult it is to bring prices down.
Manmohan Singh has presumably become more politically savvy today compared to sixteen years ago when he had to eat his words. His government is trying its level best to douse the inflationary fires that are burning. But is it an instance of ‘too little, too late’?