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Friday, February 21, 2014

Soaring Inflation: What Its Control Calls For

As year 2008 started, the fairy tale of global economy came to an end. Suddenly, inflation has become a worldwide problem. The soaring oil and food prices that were once perceived as a mere blip in the growth cycle have suddenly become the spoilsport of the central banks, challenging their wits to keep them under check. This has obviously made the central banks nervous, for inflation expectations, once entrenched deeply, becomes difficult to be eliminated. This is reflected in Ben Bernanke’s recent attempt to resurrect the dollar: “We are attentive to the implications of changes in the value of dollar for inflation and inflation expectations.” The anxiety of central banks to tame inflation is so high that no sooner did Bernanke talk up dollar than Trichet, the Chairman of European Central Bank, gave a strong hint about the likely rise in their interest rates. This simply pushed euro higher, defeating Bernanke’s efforts at giving a gentle push to dollar, besides causing turmoil in bond markets.

Amidst this pandemonium in global markets, India took some bold steps—both on fiscal and monetary fronts. First, the government, realizing that “there are limits to which we can keep consumer prices unaffected by rising import prices”, has hiked the retail prices of petrol and diesel by about 10%—Rs 5 per liter of petrol and Rs 3 on diesel—and cooking gas by 30%, besides scrapping a 5% import tariff on crude oil—all to reduce not only the under- recoveries of oil-trading companies,  but also the demand on the Center for additional oil-bonds that merely defer government’s financial liability for OMCs to a future date.

On the monetary front, the Reserve Bank of India, for the first time in more than a year, raised its repo rate by 25 basis points to 8%—a five-year high—and perhaps all set to raise it by another 25 basis points soon. The move, though received by industry with a shudder, has become essential for more than one reason: one, it has to fall in line with global central banks, else there is the danger of rupee, which has already depreciated by 8% against dollar, depreciating further, including against other currencies which incidentally, means costlier imports; two, the  widening current account deficit is posing a bigger challenge, particularly, in the context of falling foreign portfolio inflows into a none-too-happy stock market; and three, to anchor the inflationary expectations at acceptable level, it cannot afford to let real interest rates turn negative.

Unsurprisingly, the government’s act of passing on the raising crude prices to consumers has, of course, generated backlash on predicted lines.  The displeasure of the common man at the rise in the prices of petroleum products, that too, over the already rising inflation—which has touched 11.5% by June 20 —is understandable, but what is more disturbing are the roadblocks and street demonstrations organized by the political parties. It only demonstrates that either they are ignorant of the ground realities or not caring for them. The former cannot, however, be true for one cannot presume them to be unaware of basic economics: prices are to necessarily be able to change relative to the underlying production costs—between February and June of the current year the crude price has gone up from $90 to $135 per barrel.  They are also aware that the mounting oil subsidy is no longer fiscally sustainable, for we import almost 80% of our oil consumption.  It is also a matter of common sense that raising the prices of petroleum products is the core of any policy response, for it alone can—though not directly—keep the spiraling fiscal deficit under check, which is essential to keep public investments intact—at least ensure the availability of funds for more deserving programs such as NREGS. In fact, such transfer of prices, proportionate to the increase in the global crude prices, should have been done regularly to obviate the fiscal profligacy as also to reduce the imposition of sudden and heavy burden on the consumers. Such decisions, though  would be painful in the short run, are certain to avoid far more pain resulting from a fall in growth owing to higher inflation rate or fiscal deficit, or a combination of both, widening the current account deficit, and the resulting depreciation of rupee, in the long run. Capping it all, such willingness to effect policy changes domestically is a must under the global slowdown; else, we will remain at the mercy of global economic happenings.  Despite these hard realities, if political parties continue to resort to such agitations, it only means that they are bent upon blaming the ruling party, irrespective of the fact that the current hike is not something that is in their control.

Which reminds us of what Sanjay Bagchi once observed:  Indian politician assigns the highest priority to the interests “not of the nation but of his party, and within the party, to the interests of himself, his family, his clan, his caste (and) his constituency.”  Instead, opposition parties, as the democratic theorists often fondly said, essentially being a “government-in-the-waiting”, cannot afford to “oppose, oppose, oppose” but “should so conduct itself…as to persuade the people of the country that it could be an improvement on the government of the day”, which means, educating the citizens about the economic realities and encouraging them to sail through the difficult times. 

Or, is it a far cry?

                                                                                                                                             (July, 2008)


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