Govt must cut import duty rates to combat inflation
Not surprisingly, inflation has surged, consumption has faltered, and the Indian rupee has weakened. The RBI has already started raising the interest rates and sucking out excess liquidity in the system. The government should now step up and consider how tariff reductions can address the growing inflation concerns.
By all accounts, inflation in India is not due to overheating of the domestic economy or any sudden spurt in demand but due to global factors such as high commodity prices caused by supply disruptions and liquidity overhang. So, it is difficult to say whether the actions of our monetary authorities alone will help bring down the prices. Jahangir Aziz of JP Morgan says while there is clearly a case to remove the extraordinary monetary support provided during the pandemic, constraining credit growth by raising interest rates can result in weakening the demand further and lowering the growth rates.
Globally, many rich countries are curbing money supply and raising interest rates in the hope that consequent drop in economic activities will lower overall demand and bring down the prices. While that may actually happen over a period of time, a lot depends, besides other factors, on how the war in Ukraine plays out and how soon the Covid induced lockdowns in China end. So, our government need not merely wait for the global commodity prices to drop but take active measures to supplement the actions of the monetary authorities. One of them must be trade liberalisation and cutting import tariffs.
In a recent policy brief, economists at the Peterson Institute of International Economics,
Gary Clyde Hufbauer, Megan Hogan, and Yilin Wang argued a fea- sible package of liberalisation could deliver a one-time reduction in consumer price index (CPI) inflation of around 1.3 percentage points, amounting to $797 per US household, about half the size of pandemic relief in 2021 and as a bonus, the embrace of trade liberalisation would curb inflationary expectations taking hold in American firms now protected by trade barriers from foreign competition. Reviewing the paper, Larry Summers of Harvard University, a former Treasury Secretary of the US, said that when tariff is reduced, a direct effect is that the people pay less for imported goods. A second effect is that the domestic firms have to lower the prices to stay in competition. This indirect effect, according to the PIIE economists, is two to three times the direct effect but that is a conservative estimate, said Larry Summers. In India, the reluctance to reduce import duties stems not only from obligations to protect many domestic producers but also from the government that does not want to lose revenues. The memories of huge revenue losses and higher fiscal deficit, due to excise duty and service tax rate cuts during 2008-11 in the wake of the global financial crisis, which led to high inflation two years later, are still fresh. But, the current situation is quite different.
Our domestic producers have shown sufficient resilience against competition from imports and want protection mainly to beef up their profits. The government has learnt to raise resources through disinvestment and asset monetisation, rather than rely solely on tax revenues. Also, the falling rupee has helped the revenues. So, the import duty rates can be cut without much hesitation.