Moved by a close to 8 per cent retail inflation rate in April, relative to the corresponding month of the previous year, and a high 15 per cent similar year-on-year rise in the wholesale price index (WPI), India’s Central government announced late in May a reduction in the central excise duty imposed on crucial petroleum products. The reduction in the case of petrol of Rs.8 a litre and on diesel of Rs.6 a litre will, according to the Finance Minister, reduce retail prices of petrol and diesel by Rs.9.5 a litre and Rs.7 a litre and involve a sacrifice of around Rs.1 lakh crore in revenues in a full financial year. Together with a subsidy of Rs.200 a cylinder of LPG provided to the poor under the Pradhan Mantri Ujjwala Yojana and some import tariff reductions, this package of measures was presented as a major intervention to rein in inflation. However, the use of excise duty reductions as an anti-inflationary tool is unusual. It suggests that the government is implicitly admitting that its reliance on indirect tax imposts on oil products has triggered an engineered inflation, which cannot be reined in only with monetary policy initiatives like interest rate hikes by the Reserve Bank of India.
There is reason to believe that this intervention has come rather late and is not based on an adequate analysis of the drivers of the current inflation. When India’s WPI rose in March 2021, and reflected a month-on-month annual increase of more than 6 per cent, the development was seen as transient and not troubling. This was because the increase was partly attributed to the low base values to which the 2021 indices were being compared (inflation in April-May the previous year averaged just 2.5 per cent) and was seen as largely driven by transient increases in oil prices. Moreover, the rise in the WPI had not affected the prices paid by consumers too much. Inflation as measured by increases in the consumer price index (CPI) was at a lower and still comfortable 5.5 per cent in March 2020, and while COVID-related lockdowns had affected supply, they had also reduced earnings and depressed demand. Managing the pandemic and stimulating economic recovery, rather than inflation, were seen as the prime concerns.
Russian invasion of Ukraine
But, even before the Russian invasion of Ukraine in February 2022 restricted supplies of a range of commodities, especially oil, gas, and foodgrains, much had occurred to change perceptions. To start with, inflation not only persisted but gained momentum. As measured by the WPI, it averaged 11 per cent during March-June 2021, 12.2 per cent July to October 2021, and 14.1 per cent between November 2021 and February 2022. Second, food and raw materials (agricultural and mineral) had been added to the list of commodities experiencing an inflationary surge. The average movements of the WPI for foodgrains in the three time periods mentioned earlier rose from −0.4 per cent to 1.6 per cent and 4.8 per cent. Third, the exit of financial investors from India’s financial markets, triggered by global uncertainty and the prospect of the unwinding of easy money and low interest policies in the advanced nations, set off a depreciation of the rupee that raised import costs and added another element to cost push inflation. This was reflected in the increase in the WPI for manufacturing, which averaged 5.3 per cent in the first quarter of 2021 and 12 per cent in the last quarter of that year. And finally, inflation was soon reflected in movements of the all-India CPI as well. CPI increases that averaged 4.3 per cent during September-November 2021 rose to 5.9 per cent between December 2021 and February 2022.
What the Russian invasion of Ukraine did was to accelerate this underlying and pre-existing inflationary trend, taking the average WPI-based rate of month-on-month annual inflation to 14.8 per cent during March-April 2022, and that based on the CPI to 7.4 per cent. The rise in the WPI for crude petroleum of 75 per cent on average during those two months played a major role, as did an 8 per cent rise in the CPI for food. The result is that not only has the return of inflation not been as transient as expected but it has also been more widespread in nature.
Oil seed silos and oil storage tanks at the Port of Giurgiulesti in Moldova on May 20. Russia’s invasion of Ukraine has hampered exports of sunflower oil and worsened a global shortage. | Photo Credit: Nathan Laine / Bloomberg
Unable to dismiss inflation as transient and trivial, the government was initially focussed on attributing it to external and/or exogenous factors outside its control. An obvious exogenous factor was the spike in global oil prices. Brent crude prices fell from $66 a barrel at the beginning of 2020 to $17 a barrel in late April 2020 because of the early effects of the COVID-19 pandemic on global growth but soon turned around. Those prices rose to $87 a barrel by end October 2021 and $94 a barrel in February 2022 before the Russian invasion of Ukraine. A second exogenous shock was the more generalised inflation resulting from the demand revival triggered by the waning of the pandemic, the relaxation of restrictions on economic activity, and the effects of stimulus spending in response to successive waves of the pandemic. The demand revival hardened prices because of the unwillingness of the Organization of the Petroleum Exporting Countries plus (including Russia) to ramp up oil supplies to hold down prices, the sluggish restoration of global supply of a range of commodities, and the inflow of speculative capital into commodity markets looking to gain from the asymmetric revival in demand and supply. The decision, on strategic grounds, of the United States and its allies to impose formal and informal restrictions on trade with China, which had emerged as a leading node in the supply chains that sustained consumption and investment in the advanced economies, aggravated these tendencies. It was on these underlying inflationary trends, operative in a world economy that was still producing well below its potential, that the effects of the Russian invasion of Ukraine, involving two countries that are significant suppliers in the global market for oil and gas and food, were superimposed. The result is inflation in the advanced economies of a magnitude that has not been matched for the last four decades.
India’s government and its supporters had argued that it is the spillover of this global trend rather than domestic factors that explains domestic inflation. This also implied, in their view, that domestic policy intervention can do only that much to rein in that inflation. However, what needs to be noted is that the effects of these global trends were amplified by the consequences of a number of neoliberal measures the Indian government adopted. Prime among these was a set of measures relating to the oil economy. As part of the neoliberal turn in policy since the 1990s, the government transited to a liberalised pricing regime, which linked the prices of oil and oil products in India to volatile global prices. In addition, in an almost cynical move, the government at the Centre—which has eroded its own tax base by offering a range of tax concessions to the corporate sector and the well-heeled—had periodically hiked taxes on oil and oil products to shore up its revenues, rendering oil prices buoyant.
Finally, neoliberalism had eroded the taxation powers of the States, aggravated by the shift to a goods and services tax regime in which taxes on most goods are outside the jurisdiction of individual State governments. Among the few exceptions are oil and oil products, which have attracted additional State-level imposts by cash-strapped State governments. That has only added to the tax-driven buoyancy of oil prices. Since oil products directly or indirectly enter into the costs of most commodities, either as inputs or as transportation costs for example, this has affected the prices of almost all goods in the economy, contributing to generalised inflation.
The role of domestic policy in driving inflation does not stop here. The transition to a liberalised policy regime also involved the relaxation of capital controls that gave foreign investors, including speculative financial investors, easy access to Indian markets. This open economy policy has encouraged a huge inflow of speculative and footloose capital into the domestic economy over the last decade. It resulted in the accumulation of a large volume of legacy foreign finance in domestic markets. As is to be expected, capital of this kind flows out when times are not good, as is the case currently. The immediate fallout of that flight of capital out of emerging markets, including India, is a significant depreciation of the rupee, which substantially increases the rupee costs of imported intermediates and components entering into a production structure reshaped by trade liberalisation. This is another contributing factor to generalised price inflation, which the government now seeks to counter with import duty reductions.
Finally, a liberalised food policy regime has contributed to food price inflation. After having languished for two years, production of foodgrains spiked in 2016-17 and 2017-18, remained at that high level in 2018-19, and rose further in 2019-20, 2020-21, and 2021-22. The result of this is that despite enhanced (and partly free) distribution of foodgrains to beneficiaries under the National Food Security Act, stocks of rice and wheat in the Central pool in April stood at 564 lakh tonnes in 2021 and 513 lakh tonnes in 2022, which was well above the buffer-stocking norm (operational and strategic combined) for April of 210 lakh tonnes. Under normal circumstances, the combination of enhanced supply through the public distribution system together with the availability of large stocks should dampen price increases of this sensitive set of commodities.
Exports profitable
If there is an identifiable trend of food price inflation, it stems from the failure of the government to ensure a reasonable degree of procurement in a year in which foodgrains production is expected to fall short of expected levels. International prices are ruling high, and exports are a profitable alternative. The private trade is therefore willing to offer a price higher than the minimum support price that the government offers for procured grain. With private trade free to operate and exports permitted, this also encourages speculative stockholding on the part of the private trade. The net effect is a tendency for the displacement of government procurement by private procurement, tight supplies in the market, and a spike in domestic prices of food. This forced a government that was canvassing support for grain exports from India to suddenly declare a ban on exports of wheat.
In sum, a number of policies, going well beyond excise duty adjustments, have not only rendered India prone to imported inflation but also significantly amplified that rate of inflation. This inflation is as much engineered, knowingly or unwittingly, as it is imported. Merely adjusting excise duties may not be enough to rein in the runaway increase in prices.
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