Hard times ahead
High global commodity prices, including of crude oil, the depreciation of the rupee, and supply chain breaks due to China’s ongoing lockdowns have all contributed to the present inflationary pressures. The Central government should be concerned about the impact of inflation
on macroeconomic stability.
THE COUNTRY HAS FACED WORSE inflationary situations in the past. The increase in Consumer Price Index (CPI) in April to 7.8 per cent is, however, the highest since May 2014. High inflation was one of the factors that sparked voters’ outrage against the United Progressive Alliance (UPA) government in its second term (2009-14). The first term of the Narendra Modi-led National Democratic Alliance (NDA) regime (2014-19) and COVID times have been relatively quiet on the inflation front. But since then the relentless rise in prices has once again become a major socioeconomic issue.
It is strange that the Finance Ministry’s monthly economic review for April claimed, “While inflation is expected to be elevated in 2022-23, mitigating action taken by the Government and RBI [Reserve Bank of India] may reduce its duration. Evidence on consumption patterns further suggests that inflation in India has a lesser impact on low-income strata than on high-income groups.” Small wonder that a tweet relating to this became the subject of general ridicule in the social media and the Finance Ministry had to issue a denial.
“A Tweet with the picture of Union Finance Minister @nsitharaman is being circulated claiming that the Finance Ministry has stated—‘inflation will affect the rich more than the poor in 2022.’ The Claim is fake. @Finminindia has not given such statement,” the Press Information Bureau’s fact check division posted on its Twitter handle. But the statement quoted earlier in the Finance Ministry’s official report remains.
COST OF LIVING RISES
This raises the question as to who are the winners and losers in the inflation game. It is easier to identify the
losers. Consumers, particularly poor and ordinary citizens, will have to pay higher prices for goods and services. This means that with their income remaining the same, they can purchase only less than what they could before inflation. Their real income has declined.
We also have to bear in mind an important aspect of the POST-COVID situation. The national income has barely recovered to PRE-COVID levels, and the current year’s expected growth has been downgraded to around 6 per cent. The economic downturn that has occurred since demonetisation, which brought the economy to 3 per cent growth on the eve of COVID, affected the unorganised sectors severely. The situation worsened with COVID. There has been an astounding widening of inequalities. Further, the household debt from the COVID period will eat into disposable incomes. For these reasons the current inflation will make a serious dent on the standard of living and welfare of the poor. The current inflation bites deep.
CONSUMER PRICE INDEX
The National Statistical Office (NSO) and the Labour Bureau publish consumer price indices to measure the impact of price rise on different sections of consumers. Among them, the CPI prepared by the NSO is the most broad-based indicator of the impact of inflation on consumers in general.
Retail prices of relevant commodities and services consumed are collected, and indices prepared taking prices of 2012 as base year. Weightage is assigned to them in proportion to their relative importance in the consumption basket. The weighted average will give the consumer price index.
The largest component is the food and beverages group, accounting for 46 per cent of the total. Cereals and products are the largest component in this group, with a weightage of 10 per cent. Other important items are clothing and footwear, housing, and fuel, with a weightage of of 6.5 per cent, 10 per cent and 6.8 per cent respectively. Among services, education and health account for 10.4 per cent, and transport and communication account for 8.6 per cent.
FOOD PRICES
The key drivers of the surge in the CPI have been fuel and food items, especially vegetables, spices and oils/fats, and household services. The food price inflation surged to a 17-month high of 8.38 per cent in April from 7.68 per cent in March. In April, prices of cereals and products touched a 21-month high of 5.96 per cent, largely reflecting the failure of procurement and unregulated wheat exports. Prices of vegetables and spices reached a 17month high of 15.41 per cent and 10.56 per cent respectively. Evidently, the poor who spend a larger part of their income on these goods suffer the most.
Transport and communication inflation increased to 10.91 per cent in April from 8 per cent in the previous month because of rising fuel prices. Inflation for miscellaneous goods and services reached a 115-month high of 8.03 per cent, marking 23 consecutive months of inflation above 6 per cent. The cost of education and health services has also increased. Inflationary pressures are spreading to every segment of consumption.
FUEL PRICES
The persistence of high and rising oil and coal prices has contributed to the overall effect of inflationary pressures on the economy. Petroleum being a basic intermediate product, this outcome was inevitable sooner or later. The rise in crude oil prices, which undoubtedly is the primary factor responsible for fuel inflation, must be read along with the fiscal policy of the Government of India. With large corporate tax concessions and the resource mobilisation strategy increasingly focussed on indirect taxes, the tax to GDP ratio of the country has tended to stagnate in recent years. With the GST (goods and services tax) fiasco, hiking the taxes on inelastic petroleum products was viewed as an effective option.
It was indeed a surgical strike. The tax on petrol and diesel was increased 12 times since 2014. As a result, the tax on petrol increased nearly three times, from Rs.9.4 to Rs.26.77, and the tax on diesel nearly 9 times, from Rs.3.56 to Rs.31.47. There is no parallel in Indian financial history of such cold-blooded and astounding hike in the tax rate of any commodity. As a result, the revenue from the petroleum sector increased from Rs.1.72 lakh crore in 2014-15 to Rs.4.55 lakh crore in 2020-21 and Rs.4.16 lakh crore in 2021-22.
The Modi government’s total revenue from petroleum taxes during its eight-year tenure is Rs.26.52 lakh crore. The total number of households in India would be around the same number (24.67 crore, 2011 Census), which implies that on an average an Indian household paid Rs.1 lakh as petroleum tax. It has been looting of the poor. The Central government’s petroleum tax to GDP ratio increased from 0.8 per cent in 2014-15 to 1.9 per cent in 2020-21.
RIGGED MARKETS
Fortunately for the NDA regime, its ascendancy coincided with the decline in international crude oil prices. The tax escalation was calibrated to ensure that the gains of lower crude oil prices were not passed on to consumers, but were mopped up as additional tax revenue. The protests were muted because there was no increase in retail prices. Even during COVID times, the tax was raised ruthlessly.
But when international crude oil prices began to firm up, the Central government refused to reduce the tax until the danger of inflation getting out of hand appeared on the horizon. In November 2021, the taxes were reduced by Rs.10 and Rs.5 per litre for diesel and petrol respectively. After the April CPI figures became public in May 2022, the taxes were reduced by Rs.6 and Rs.8 per litre for diesel and petrol respectively. Even now the government is unwilling to roll back the entire hike in taxes on petroleum effected from 2014. Even with the danger of price spiral looming,the Modi government is
clinging to an additional tax of Rs.12.27 for petrol and Rs.10.47 for diesel.
As the Ukraine war drags on, the global commodity prices, including that of crude oil, are likely to remain high. The supply chain implications of the continued lockdowns in China also are likely to compound the situation further. Sooner rather than later, the additional burden on consumer goods manufacturers because of higher input costs will be passed on to consumers. This will result in the spread of inflation to manufactured product sectors and create a generalised inflationary situation.
Another factor that is pushing up the cost of inputs is the depreciation of the rupee. From Rs.64 to a dollar, the exchange rate has come down to nearly Rs.78 to a dollar. This means that to import the same units of commodities or services purchased at Rs.64 in 2014, the importers will now have to cough up Rs.78.
The trends in the Wholesale Price Index (WPI) are an indicator of the above outcome. The WPI reflects the wholesale prices of commodities and, unlike the CPI, it focusses on inputs rather than consumer products. The WPI has been continually much above the CPI, and in April 2022 it reached a 30-year high of 15.08 per cent because of an across-the-board rise in prices of all segments. The WPI inflation has been in double digits during the past 13 months. Year-on-year rise of crude oil and petrol prices has been above 60 per cent, resulting in a 39 per cent inflation rate in the power basket. In manufactured products it was 11 per cent. High and persistent input prices may be absorbed by manufacturers in the short run at the expense of their profits, but in the medium term this will be passed on to retail prices.
THE BENEFICIARIES OF INFLATION
The ultimate buyers, the consumers, will have to transfer a substantial portion of their income to the sellers—the traders and manufacturers. Inflation is a process of transferring income from buyers to sellers. It is very unlikely that the primary producers whose markets are controlled by the former will benefit from the commodity boom. And the government also stands to benefit, as our brief discussion on oil prices has exposed. But the people and the country stand to lose.
A recent Oxfam report, ‘Profiteering from Pain’, has concluded that every 30 hours one billionaire is born while nearly 1 million people crash into extreme poverty. The system is so rigged that whether it be Covid-linked recession or POST-COVID inflation, the rich gain and the poor suffer.
RBI INTERVENTION
Price is the outcome of the interaction of demand and supply forces. The main actor trying to rein in prices has so far been the Reserve Bank of India, with monetary policy being its main instrument. In order to support weak demand and ensure growth, the RBI has been following a low interest rate and easy money policy. It continued to hold on to this position until very recently under the benign assumption that the retail inflation rate would remain below the upper limit of its target of +/-2 per cent of the normal inflation of 4 per cent. A few weeks after its regular April meeting of the Monetary Policy Committee (MPC), the RBI had to wake up to the hard reality of inflation and hurriedly reverse its monetary stance.
An unscheduled meeting of the MPC on May 4 decided to raise the repo rate from 4 per cent to 4.4 per cent and increase the cash reserve ratio to 4.5 per cent from the existing 4 per cent while maintaining the accommodative stance. It is the beginning of an attempt to remove excess liquidity in the economy to contain inflation. It is evident that the policies pursued during the past two years will be reversed in the coming months, and the monetary policy will retreat to the PRE-COVID moorings.
ACTION NEEDED ON SUPPLY SIDE
The above approach assumes that excess demand is a major factor in triggering inflation. But more important are supply-side constraints pushing up the cost. It is more of a cost-push inflation than the classic demandpull inflation. The attempt to squeeze demand will have serious adverse consequences for growth. It can undermine recovery.
Therefore, a more resolute action is required on the supply side. The entire additional taxes imposed on petroleum products will have to be rolled back. Cereal procurement must be speeded up and the public distribution system strengthened. The oligopolistic pricing by business house cartels must be curtailed and competition promoted. It may be noted that retail prices in Kerala and Tamil Nadu, which have more robust public distribution systems, are relatively much lower than in the rest of the country.
THREAT TO STABILITY
Inflation has serious implications not only for distribution and growth but also for economic stability. High inflation has been an important factor behind the depreciation of the rupee, leading to imported inflation. The rupee is already at its historic low and is heading towards Rs.78 to a dollar from Rs.64 in 2014. After a meteoric expansion of foreign exchange reserves during the past four years, primarily through foreign capital inflow, we are witnessing withdrawal of funds by foreign investors, resulting in an erosion of foreign exchange reserves. There is no chance of reversing the new trend if inflation accelerates.
Even if the Central government is not much bothered about the distributional implications of inflation, it should be worried about its implications for macro-economic stability. There is little chance of a repeat of the 1991 events, when planeloads of gold had to be transported to London to pay for foreign exchange. But clearly, hard times are ahead. m Thomas Isaac is the former Finance Minister of Kerala and central committee member of the Communist Party of India (Marxist).