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The Inflation Monster

Politicians dread inflation. High prices rapidly deplete popularity. In particular, the poor are hurt more than the rich. After an uneven monsoon, the ghost of inflation has come to haunt the Manmohan Singh government.

Politicians dread inflation. High prices rapidly deplete popularity. In particular, the poor are hurt more than the rich. After an uneven monsoon, the ghost of inflation has come to haunt the Manmohan Singh government. In early-August, the point-to-point comparison of the official wholesale price index yielded an inflation rate above 7.5 per cent, the highest in more than three years. What is worse for the government is that this rate is certain to rise in the coming weeks before it starts declining in September. The annual inflation rate for the current fiscal year is hovering around the 5.5 per cent mark. The last occasion the annual inflation rate had exceeded 7 per cent was in 2000-01 (7.2 per cent) and before that, in 1995-96 (8 per cent).

Part of the sudden rise in the inflation rate can be explained in statistical terms or through what economists describe as the "base effect", that is, on account of the fact that around the same time last year the inflation rate was at a relatively low level. But this is only one small part of the story. The most important reason why the inflation rate has jumped is because of the incredibly high world prices of crude oil. Given the fact that international oil prices are currently ruling at record levels, the economy of a country like India that imports close to three-fourth of its requirements of crude oil and petroleum products (much of it from the Middle East) was bound to be badly hit. The worst apprehensions that were expressed about the fallout of the US invasion of Iraq seem to have come true.

What has compounded the problem for the incumbent government is that its predecessor regime had consciously refrained from hiking domestic prices of petroleum products during the first half of the calendar year for reasons that had nothing to do with economics. The decision not to increase prices was a purely political once since general elections were scheduled to take place and an already-unpopular government did not wish to take a risk by allowing petroleum product prices to go up that would surely have offended voters.

While the earlier administered pricing mechanism for petroleum products had been done away with from April 1, 2002, and the government had begun cutting subsidies on politically-sensitive products like kerosene and cooking gas, the government at the same time had hypocritically arm-twisted so-called autonomous oil PSUs by preventing them from increasing prices although raw material costs were rising rapidly. The consequence of this hypocrisy had to be borne by the new government.

Can the government do anything at this juncture to ameliorate the impact of high oil prices? Frankly, it can do precious little. The excise and customs duties could be tinkered with but any drastic cut in taxes on crude oil as well as transportation fuels like petrol and diesel would compress revenues.

Various monetary measures too have been suggested to the RBI to curb inflationary pressures. One suggestion is that the RBI should allow the rupee to appreciate vis-à-vis the US dollar. This would make imports relatively cheaper. But the flip side is that exports would become more expensive. The RBI could also mop up excess liquidity in the system due to the country's high foreign exchange reserves by increasing the cash reserve ratio of banks, by issuing more market stabilization bonds and by stepping up the repo rate. While such steps would tighten money supply, the consequence of such moves could be a hardening of interest rates.

The short point is that irrespective of the combination of fiscal and monetary measures that are implemented, there are no easy options before the government to check the runaway rise in the inflation rate.

(The author is Director, School of Convergence, International Management Institute, New Delhi, and a journalist with over 25 years of experience in various media. He can be contacted at [email protected])