The Hindu Business Line : Price spiral: External factors, the culprit

Though the runaway rise in prices witnessed recently is largely a consequence of factors beyond the control of the UPA Government, the new regime will nevertheless have to bear the consequences of the sharp increase in the inflation rate. What is worse, the Government can do little or nothing about it because the circumstances responsible for the increase in the inflation rate are external in nature, says Paranjoy Guha Thakurta

THE sudden spurt in inflation is threatening to upset the country's economic equilibrium. While the runaway rise in prices witnessed recently is largely a consequence of factors beyond the Centre's control, namely, uncertainty about the monsoon and excessively high international prices of crude oil and petroleum products, the new United Progressive Alliance regime will nevertheless have to bear the consequences of the sharp increase in the inflation rate that translates into political unpopularity during what should have been its "honeymoon" period.

What is worse for the Manmohan Singh Government is that it can do little or nothing to contain prices simply because the circumstances responsible for the recent increase in the inflation rate are external in nature.

The fiscal measures initiated so far — the reduction in taxes on petroleum products and steel — can at best cushion consumers from the shock of high oil prices but would eventually prove to be palliatives that provide temporary relief and not cure the bigger problem — India's dependence on imported crude oil, which in turn makes the country highly vulnerable to volatile energy prices.

On August 20, the point-to-point inflation rate, as measured by the official wholesale price index for the week ended August 7, touched nearly 8 per cent (7.96 per cent, to be precise), the highest in three-and-half years (42 months).

The same day, news came in that the Finance Ministry had cut the Customs duty rates on different categories of steel by proportions varying between 5 per cent and 10 per cent. More ominously, the price of crude oil in the American market raced to a record high of more than $49 a barrel, sending jitters through the economies of oil-importing countries, including India and China.

A fortnight earlier, the WPI had risen by more than 7.5 per cent. In the corresponding weeks in 2003, the inflation rate had stood at less than 4 per cent. The annual inflation rate (as opposed to the point-to-point rate on any given week) during the current financial year is hovering around the 5.5 per cent mark but moving inexorably towards 6 per cent.

If world oil prices do not ease, there is a strong possibility that 2004-05 would conclude with an annual rate of inflation somewhere between 6.5 per cent and 7 per cent. The Budget for the current fiscal had implicitly assumed a nominal rate of growth of gross domestic product of 12 per cent.

The Government would have liked to achieve this nominal growth rate by keeping inflation at around 5 per cent, which would have meant a real rate of growth of GDP in the region of 7 per cent.

It is now almost certain that such fond hopes would be dashed. The inflation monster has ensured that the Finance Minister, Mr P. Chidambaram's arithmetic will go awry even before this year's delayed Budget is formalised and long before next year's Budget is presented.

The last two occasions the annual inflation rate crossed 7 per cent were in 2000-01, when the inflation rate was 7.2 per cent, and in 1995-96, when the figure had stood at 8 per cent. The annual rate of inflation had come down quite significantly between 2002-03 and 2003-04: from 6.5 per cent to 4.6 per cent.

That inflationary pressures were building up became apparent early this year. In early-January, a point-to-point comparison of the WPI yielded an inflation rate in excess of 6 per cent.

Subsequently, however, this rate came down and remained below 5 per cent all the way through March, April and early-May — that is, till the results of the 14th General Elections were announced. Towards the end of May, the inflation rate crossed the 5 per cent mark and by the end of July, the rate had gone above 6.5 per cent.

To some extent, the rise in the inflation rate could have been predicted. Even before July, when it appeared as if the monsoon would be uneven and that there would a shortfall in precipitation in the country's "grain bowl" of Punjab, Haryana and western Uttar Pradesh, with excess rainfall leading to floods in Assam, Bihar and Gujarat, prices of sugar and edible oils had begun firming up in anticipation of a possible poor harvest.

By August, however, the monsoon had revived. But, by then, international oil prices had shot through the ceiling. Given the trend in the inflation rate in 2003, what could have been forecast without too much difficulty is the impact of what could be termed the "base effect".

In lay language, if the base of the inflation rate measured during a particular week is relatively low, the inflation rate will rise relatively faster. The reverse is also true, which is why it can be safely predicted that the inflation rate will fall in the coming months. There is, of course, one big snag. And that is, oil prices.

Given the pattern of inflation in the previous year, what came through as a show of bravado were the reported statements of the Chief Economic Adviser in the Ministry of Finance, Dr Ashok Lahiri, in the last week of July and the first week of August. On each occasion, Dr Lahiri was quoted as saying inflation had "stabilised". He even went on record stating that the inflation rate was "unlikely to rise from the current level".

We know that officials in North Block are always supposed to paint a rosy picture of the economy and are paid to be incorrigible optimists. Still, the CEA's statements were clearly out of synch with reality, especially since the writing on the wall was pretty clear.

The year 2003-04 had begun with double-digit (11.2 per cent) inflation for the fuel group in the WPI. World oil prices, which had shot up before the US invasion of Iraq began in March 2003, started slackening thereafter. But the story that followed is all too familiar to be repeated. There was no absolutely let-up in the increase in global crude prices.

Domestic trouble in oil-exporting countries like Nigeria and Venezuela made the situation worse, as did the financial scandal afflicting the Russian oil major Yukos. At a time when international supply of and demand for crude oil were finely balanced, the rise in demand during the summer months and, more importantly, the continuing conflict in Iraq, resulted in crude oil prices hitting unprecedented highs.

After the first two oil price shocks in the 1980s and the third in 1990, after Saddam Hussain's invasion of Iraq, history will probably remember the period we are currently going through as the phase of the fourth oil shock.

For a country such as India, that is importing close to three-fourth of the country's requirement of crude oil, most of it from West Asia, the news could not have been worse.

What compounded matters for the new Government was that the earlier government deliberately did not allow public sector oil companies to increase the domestic prices of the two main transportation fuels, petrol and diesel, because it did not wish to become more unpopular than it was in the run-up to the April-May general elections.

Thus, so-called autonomous refining and marketing companies were arm-twisted by the government of the day not to increase petroleum product prices although world prices were rising steadily. Such a denouement was indeed ironical because this was the same government that had done away with the administered pricing mechanism for petroleum products with much fanfare in April 2002.

The Government has cut excise and Customs duties on petroleum products. But, as already mentioned, this move can at best help contain inflation only for a short period if world oil prices do not ease.

Two years ago, there was much concern expressed about deflation in countries such as Japan, Germany and, even, China. Today the situation has undergone a dramatic change.

At present, the inflation rate in China has exceeded 5 per cent — one of the highest in recent years. In the US, the inflation rate has gone up from 2.1 per cent to 3.3 per cent. It would be next to impossible to insulate India from the result of the world.

Back at home, for the harried householder whose real income is fast shrinking, it is no consolation that global inflation is also on the rise.

(The author is Director, School of Convergence and a journalist with over 27 years of experience in various media — print, radio, television and the Internet. He can be contacted at paranjoy@yahoo.com.)