Tackling inflation: Govt on the right track?

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Home > India > Business > Columnists > Guest Column > Business Standard

Tackling inflation: Govt on the right track?

May 01, 2008

The government has got down to tackling inflation with all the weapons in its armoury -- tariff cuts, export restrictions, physical controls, administrative measures to prevent stockpiling -- while the Reserve Bank has tried to squeeze out excess liquidity.

On the evidence so far, one thing that has been achieved is the psychological impact of the broad message that inflation will be tackled firmly, and that is half the battle. Whether specific product markets have responded to the measures announced remains to be seen, though on the face of it steel producers have agreed to price roll-backs.

Beyond these developments, however, the government has been fortunate in that the rabi harvest has turned out to be good, while food procurement has exceeded the levels achieved in recent years (in part, because private trade was kept out of the market by the imposition of various controls). Secondary food items like fruits and vegetables are in any case subject to short crop cycles and their prices fluctuate all the time.

Internationally, there is evidence that the commodity price spiral is now levelling off for most items, including some agricultural items like pulses, and may well decline gradually over the next couple of years -- with the exception of petroleum, where the prognosis seems to be that prices will keep rising.

What deserves notice, when looking at the future, is the fiscal and other costs of the government's strategy. The finance minister told Parliament on Tuesday that subsidies on items like food, fertiliser and petroleum products are inevitable, and that when these subsidies reach unsustainable levels (as they have), the government has no choice other than to defer the burden to subsequent years through the issue of oil and fertiliser bonds.

He has also responded to the criticism of the fiscal deficit climbing as a consequence of the subsidies, by pointing out that the deficit level today is lower than it was in 2004. Some of this is understandable, and some of it must pass as parliamentary jousting. The questions that Mr Chidambaram has not addressed, however, are three: What will he and the government do if oil prices stay where they are or climb still higher?

Second, if domestic prices stay significantly lower than true cost for an extended period of time, isn't the government transmitting the wrong price signals? Finally, how are the fertiliser and oil marketing companies to cope with a situation where they are strapped for cash and the bonds that the government gives them in lieu of a cash subsidy cannot be encashed except at a substantial discount? In short, is the government's strategy on subsidies and issuing of bonds sustainable?

The answer, going by market expectations of where oil prices are headed, is that it is not. Business Standard had suggested a couple of weeks ago that the problem of the oil and fertiliser companies can be resolved if the bonds issued to them can be used by banks to meet statutory liquidity requirements, for that would radically improve the marketability of the bonds.

A second solution has to be the price option -- the government has to pass on more of the cost increases because not doing so invites too many dangers. It is hard for any government to announce price hikes on important items of consumption in a year marked by several important elections, but these are times when tough decisions have to be taken, if the economy is not to reap the whirlwind tomorrow.

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