Engineered inflation

Published : Jul 30, 2010 00:00 IST

AT A MARKET in Chennai. The government's failure to control the prolonged inflationary crisis seemed to signal that it could not care less about inflation and its effects on the poor majority that is experiencing a decline in real incomes.-PHOTO: S.S. KUMAR

AT A MARKET in Chennai. The government's failure to control the prolonged inflationary crisis seemed to signal that it could not care less about inflation and its effects on the poor majority that is experiencing a decline in real incomes.-PHOTO: S.S. KUMAR

The fuel price hike has serious implications for the soaring price levels, and the July 5 bandh conveys the people's anger.

THE July 5 bandh against the recent hike in the administered prices of petroleum products did shut much of the country down. This may or may not shake the United Progressive Alliance (UPA) II out of its indifference to political and parliamentary disagreement on the correctness of its manifestly elitist economic strategy which favours industry, finance and the well-to-do over the common person. But it does seem to mark a turning point in the six-year-long innings of the UPA in government. The claim that the UPA and its economist-Prime Minster has managed to build a consensus around the market-friendly, pro-business, neoliberal strategy it pursues has been challenged not just by the political opposition to it but also by the mass support that opposition has received, as reflected in the success of the bandh.

The fact that there is no such consensus but only an artificial one constructed by a governmental propaganda machinery and an elitist media is corroborated by many developments. For example, the myth that there is no opposition to inflation partly because its effects are no more so damaging (presumably because Indians on average are richer now and can afford it) and partly because some inflation is recognised as the unavoidable outcome of adjustments needed to promote growth, has been exposed for what it is: a myth. Political circumstances may have delayed strong public expression of anger, but such anger was clearly there and is now visible on the streets. It has clearly not been diluted by the periodic claims of apologists labelled as economists (non-resident, imported or locally cloned) that if we wait a few months inflation would just go away.

Second, the opposition is now strong enough to dismiss the malicious propaganda used to delegitimise dissent against a callous set of policies that penalise the poor for no reason other than the desire to reward the insatiable appetites of India's rich. This propaganda of delegitimisation has many elements. That such dissent is merely the opportunistic coming together of the Left and the Right for political gain and not because of conviction about the correctness of their demands. That responding tosuch demands would drive the exchequer bankrupt. That the opposition to such policies, through a bandh for example, results in losses totalling thousands of crores of rupees, as established by spurious estimates purveyed by organisations, such as the Confederation of Indian Industry (CII), that represent the interests that benefit from market-driven pricing.

Finally, the lack of consensus was reflected in the official advertising campaign against the bandh launched by the Ministry of Petroleum and Natural Gas. Recognising that the opposition to the petroleum price hike was receiving public support, the Ministry decided to drop any pretence of a consensus and chose instead to manufacture one. Poorly designed advertisements occupying substantial newspaper space (at a cost, of course) asserted that the price hike was a small price to be paid today to reap big benefits tomorrow. Besides being opaque on what those benefits were and how they were to be derived from a price hike, the advertisements gratuitously declared that the bandh was not a solution. It was another matter that none was arguing that the bandh was a solution to anything other than governmental intransigence. In any case, it was unclear which problem the Ministry had in mind. In the event, the advertisements served no purpose other than that of paying off some newspapers that were using their editorial columns to justify the price hike and attack all opposition to it.

The opposition to the petrol price hike was as strong as it was because the hike came in the midst of a prolonged inflationary crisis that the government had failed to control. Coming when it did it also seemed to signal that the government could not care less about the inflation and its effects on the country's poor majority that earns money-incomes that are not indexed to inflation and is therefore experiencing a decline in real (inflation-adjusted) incomes from their already abysmally low levels.

Consider, for example, the aggregate rate of inflation as reflected by the Wholesale Price Index (WPI). The WPI figures for May reflected three worrying trends. First, for the fifth month in a row, the aggregate annual rate of inflation as reflected in the month-on-month increase in the WPI had been near or well above double-digit levels. The figures for May put inflation at 10.2 per cent over the year. Second, this inflationary surge was particularly sharp in the case of some essential commodities, as a result of which the prices of food articles as a group had risen by 16.5 per cent and of foodgrains by close to 10 per cent. Though food inflation had declined to 12.9 per cent during the weekended June 19, the figure was still high and reflected more a base effect rather than a slowing of the extent of price increase. Finally, there were clear signs that what was largely an inflation in food prices was being generalised withthe increase in the prices of fuel by 13 per cent and of manufactured goods by 6-7 per cent.

As has always been the case, the inflation has been much greater at the retail level than at the wholesale level. The retail prices collated by the Ministry of Consumer Affairs, Food and Public Distribution indicate that the average across centres all over the country at the beginning of July had increased over the previous two years' by 19 per cent forrice and wheat, 58 per cent for toor dal, 71 per cent for urad dal, 113.5 per cent for moong dal, 73 per cent for sugar and 32 per cent each for potatoes and onion. By any count this is an astounding rate of inflation, and a similar situation prevails in the case of vegetables, which are an important component in the food consumption basket of the common person.

Structural influences

The government's periodic response has been that while inflation is a matter for concern, the trend is likely to reverse itself. In his inaugural address at a conference of Chief Ministers on the prices of essential commodities held in February this year, Prime Minister Manmohan Singh said the worst was over on the food inflation front and expressed confidence that the Centre would soon be able to stabilise food prices. But it could not in practice because it did little and ignored important structural influences on the pace of price increase in the current conjuncture. One is the long-term neglect of agriculture, which has affected the level and pattern of agricultural production to such an extent that supply-side constraints are leading to inflation every time growth picks up. The sudden and sharp hike in the support prices for pulses announced recently is an acknowledgement of this problem by the government. However, given the likely lag in output responses, the immediate fallout of that price increase could be an aggravation of inflationary trends.

A second structural influence is the effect the government's policy of reducing subsidies, raising administered prices and dismantling price controls has on the costs of production. Finally, inflation is high and persistent despite expectations of a normal or good monsoon because the decision to give private trade a greater role in the markets for essentials and permit futures trading in some essential commodities has provided the basis for a new bout of speculation, which the government seems unable or unwilling to control.

While there is some consensus on the role of speculation in driving inflation, official statements ignore the importance of liberalised marketing arrangements and liberalised futures trading in ensuring that speculative expectations of a rise in prices are realised. Moreover, with its emphasis on subsidy reduction and targeting of food distributed through the public distribution system (PDS), the Centre has paid little attention to enhancing the spread and penetration of the PDS, making it a less potent instrument to combat speculation.

In fact, many States have complained that they have not been allocated adequate supplies to cater to rising demand, undermining the role of the PDS as a safeguard against inflation in open market prices.

As opposed to focusing on these matters, the UPA government has sought to divert attention and induce a sense of complacency about future price trends. Besides periodically declaring that inflation would subside in due course, the government has chosen to identify the inflation that has been with us for the past few months as being the collateral fallout of policies and developments elsewhere in the domestic and world economy. For example, at the Chief Ministers' conference, among the reasons reportedly cited for the price rise were increases in the minimum support price for farm produce instituted to help the farming community, increases in international prices, increases in demand due to the increase in purchasing power resulting from higher growth, excess liquidity in the system, inefficiencies in marketing of farm produce, and the high cost of intermediation. Many of the factors are either out of the Centre's control or otherwise positive economic outcomes that cannot be countered. This amounted to an implicit declaration that food-price inflation of some intensity is inevitable.

Moreover, in yet another indication of its callousness, the Centre sought to transfer the blame for inflation to the States. At the Chief Ministers' conference, the Prime Minister, who had earlier argued that the States were not doing enough to deal with speculation, attributed the wide gap between farm-gate and retail prices partly to the proliferation of State and local taxes, cesses and levies. Claiming that taxes on food items added an additional cost burden of as much as 10-15 per cent at the retail level, he implicitly suggested that the States should forgo revenues to neutralise some of the price increase.

Besides this, he made a case for enhancing competition at the retail level by opening up the retail trade, though the evidence elsewhere is that this merely increases concentration at the retail level and widens rather than reduces trade margins. Not surprisingly, the Prime Minister's remarks, which were hailed by senior executives of many domestic retail majors, were seen as a signal of the government's intent to allow a larger role for foreign companies in India's retail industry.

The gap widens

This was being done when evidence, even in India, suggested that allowing corporates (both domestic and foreign) to enter the market for grain and other food items had led to some increase in concentration of distribution. This contributed to the widening of the gap between farm-gate and wholesale prices and the gap between wholesale and retail prices. As a result, farmers have benefited less from periods of high prices even as consumers suffered, because the benefits are garnered by middlemen. Whether it is agricultural, energy or industrial price inflation, a few corporate and trading interests seem to be the principal beneficiaries.

It is in this context that the recent decision to hike the prices of petroleum products and the opposition it has generated need to be assessed. The immediate- and near-term impact of the oil price decision would be an aggravation of inflationary trends that currently burden the common person. Petroleum products are consumed in some measure by all. Given the fact that these products are universal intermediates, entering into the costs of production of a number of goods and services, the cascading effects of the price hike on the costs and prices of a range of commodities is likely to be significant. With prices of essentials already on the rise, the move threatens to make inflation the country's principal economic problem. It follows, therefore, that this is the worst time for hikes in and decontrol of prices of petroleum products.

The government claims that this was unavoidable because of the losses being suffered by the oil marketing companies (OMCs). When the domestic prices of oil products are controlled but the price of imported oil is rising, oil marketing companies receive from the consumer less than what it costs them to acquire the products they distribute. This leads to what are termed under-recoveries, which would affect the accounts of the oil marketing companies (Indian Oil Corporation, Bharat Petroleum Corporation, Hindustan Petroleum Corporation and IBP) that obtain their supplies of petrol and diesel from the refineries at prices that equal their import price inclusive of customs duty. According to estimates, if retail prices had not been raised under-recoveries by the oil marketing companies would have exceeded Rs.70,000 crore in the current fiscal year. Since this is unsustainable, it is argued, the hike in prices and a shift out of a controlled pricing regime is unavoidable.


The government's argument is by no means water-tight. While under-recoveries are a reality, they do not turn oil refining and marketing firms into loss-making enterprises because those firms deliver a range of products and services, the prices of all of which are not controlled. If, for example, even if we consider the profit after taxes of the most important oil companies over the past 10 years, they have remained positive in all years and quite substantially so in some. Under-recoveries are notional losses that only lower book profits relative to some benchmark. Thus, there was little danger of the industry going bankrupt even if prices had been kept at their earlier levels.

There is, of course, the question of fairness. Since there are many players involved in the industry there is no reason why under-recoveries should affect only the books of the oil marketing companies. The returns on net worth earned by the oil marketing companies are far more volatile and vulnerable than those garnered by the upstream oil companies (ONGC, OIL and GAIL). The burden should be shared by the latter, which receive prices that more than compensate for costs; by the Central government, which garners revenues in the form of customs duties and excise duties (besides dividends from the oil majors); and by the State governments, which benefit from sales taxes. This requires, for example, the oil refineries to offer discounts when selling products to the OMCs and for the government to reduce the taxes it levies on oil products in order to absorb part of the under-recovery.

The controversial question of how the burden should be shared was analysed by a committee appointed to examine the issue. Headed by C. Rangarajan, it spent much of its energies on the different stages through which imported and domestic crude is converted into petroleum products supplied to the consumer, and the cost escalation that arises as the raw material passes through these stages. The numbers suggested that there was an adequate buffer to shield domestic consumers from the effects of increases in international prices, so long as segments that can afford to take a cut in petroleum-related revenues because they have alternative sources of resource mobilisation are willing to accept such a reduction.

Thus, if at all there is an argument for price deregulation it can only be that it is for some reason wrong to expect the oil companies and the government to bear the burden of the irrational fluctuations in the global prices of oil. That argument, too, is difficult to justify.

When the industry was wholly in the public sector, the prices of oil products were treated as one set of instruments in the tax-cum-subsidy regime of the government. Any losses suffered by the industry or any shortfall in funds required for investment as a result of price regulation were to be met from resources mobilised through progressive taxes rather than from regressive price increases. The government should have adopted a similar approach in the current situation and focussed on rules that can and have been devised.

It needs to be noted here that oil prices have not been held constant in recent history. Rather the average annual increase in prices over the past two decades indicates that the increase has been much higher in the case of retail prices of petrol, for example, than in the wholesale price index for all commodities. The common person has, indeed, borne some of the burden of volatile oil prices.

The question remains as to why the government is adopting policies that transfer most of the burden on to the aam aadmi and aggravate inflation. An ideological commitment to neoliberal policies and the misplaced belief in their ability to put India on the world stage may be playing a role. But, more importantly, the government's moves or lack of them seem intended to favour corporate interests of various kinds. Hopefully, the Opposition would be able to drive home the point that the people are not willing to accept this kind of cynical extraction of surpluses for profit.

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