The Dragon Called Inflation is Wagging its Tail Again

 | July 05,2010 04:12 pm IST

The dragon is raising its head again. Inflation had jumped to a four year high of 833% for the week ended August 28.

The government officials has defended it by saying that this is not the first time that the inflation has breached the 8 mark in recent years as inflation touched 8.84% on January 13, 2001 which continued for a month till February 17. So the government feels that there is no reason to be worried as they have experienced similar times in the past.

 

The rising global oil prices and prices of domestic commodities such as steel, iron ore, edible oil and other manufacture goods, vegetables, fruits, etc, since June this year are portrayed as the real culprits that have led to the current rise in inflation in the country. Another school of thought says that the present inflation is more out of growing money supply at a higher rate than desired resulting from the accumulated foreign exchange reserves which are currently at $112 billion for the week ended September 3, 2004.

 

The finance minister has of course ruled out “knee jerk reaction” but assured that the government would take action in a measured way on the fiscal side and RBI on the monetary side, to tackle inflation. He also warned the manufacturers against hiking commodity prices.

 

What does all this mean? It simply means a general and progressive increase in prices. Under the pressure of inflation, “everything gets more valuable except money”. In other words, what Rs. 100 fetched prior to rise in inflation can no longer be acquired with the same sum; instead one needs to spend more than Rs. 100 to acquire the same commodities.

 

One school of economists strongly feel that the present rise in inflation is more of “cost push” nature, which means the rise in price level is the result of rising input costs. Theoretically, “ cost push” inflation is generated by three factors: One, rising wages; two, increase in corporate taxes; three imported inflation, which means that the imported raw material or partly finished goods become more expensive, often as a result of currency depreciation etc.

 

However, the current inflation that is rightly referred to as an “imported inflation”, is due to sky rocketing oil prices in the global markets The increase in the volume growth of Indian oil import was 7.72% during April-July 2004 as against 9.36% in the corresponding period in 2003. But the growth in the value of crude oil imports had shot to over 50% this year as against 10% in the previous year. This indicates the impact of the rising international oil price. And everybody is aware how rising oil prices adversely impact a large proportion of the country’s production activities.

 

What then needs to be done? The answer is simple: We must first learn to accept reality, for it is suicidal to deny the prevailing inflationary trends in the economy as it is after all a disease that is potential enough to destroy a society. And how can we say that that current rise in price is not that threatening as it is the “base period” effect that merely made them look more menacing on a year on year basis; i.e., the rise in current wholesale price index is not truly that threatening as it is made out to be by virtue of their comparison with last year’s low inflation rate.

 

At one point of time, government agencies aired a feeling that the worst is over and the prices are likely to come down, more so with the resumption of the monsoon, although it is anybody’s guess that the global oil prices are not likely to cool down immediately. The crude prices currently are at $44 per barrel. Even though it is showing signs of stability, still the prices are not falling. Why are these agencies fooling? It is time, we showed the courage to accept the reality and, make citizens understand the government’s willingness to manage inflation most judiciously. If in the process people are required to put up with transitional adversities, the government should prepare them to face it with a promise that these hurdles are temporary and the citizens are certainly wise enough to bear it provided the government comes out clean and transparent. To be fair to the current crop of political leadership we must, of course, admit that this trend has indeed been exhibited by the governments subsequently and hope that it becomes a norm for the future.

 

Theory associated with cost push inflation says that the standard method of fighting inflation using either monetary policy or fiscal policy to induce a recession are extremely expensive, since it can raise unemployment to frightening levels, besides pulling down the existing gross domestic product to far lower levels. As it is evident that the current inflation is an imported one, the normal monetary responses such as reducing monetary growth, rising interest rates, etc., may not yield tangible results. On the other hand, such a move is more prone to cripple the growth in the economy.

 

The Reserve Bank of India has taken steps to raise the CRR by 0.5% in two tranches. The first hike of 0.25% to 4.75% will take effect from September 18, while the second 0.25% hike would become effective on October 12. The RBI governor stated that it would suck out Rs. 8000 crores of liquidity from the system but the people will have to be patient. The obvious question is whether such a move would make a difference. The answer, in the ultimate analysis, is no. The surplus in the banking system is as much as 80,000 crores and taking out about 10% of that would hardly make a difference. Additionally, the bulk of the inflation is imported as the local prices are moving in tandem with the international prices. Any positive indicators that have emerged in the recent past about increased credit off-take from the banking system towards fresh investments by the corporates will not be choked by monetary policy initiatives, in the anxiety of arresting inflation.

 

As the surging crude oil price is a world- wide phenomenon, the government must watch out for the reaction of the larger players in the market carefully and shape its policies accordingly. Either way the current inflation calls more of fiscal policy initiatives than monetary policy measures. Against these theoretical underpinnings, the proposed move of the government to cut customs duty and excise duties on major petroleum products across the board sounds appropriate to offset the inflationary impact resulting from the rise in crude oil prices. Of course, there is a flip side to it. The government revenue may come down. This may be true in the short run but in the long run, the reduction in the duties is sure to encourage growth which is otherwise choked by any monetary policy initiative and therefore offset the revenue losses owing to reduction in rates by increasing the very’ collection base”.

 

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