Tackling Inflation

Inflation is a global phenomenon as the current inflation is not confined to India alone. The continuous rise in crude prices along with price rise in essential commodities like food grains, processed foods, metals and chemicals have contributed to the present situation. Poor production and diversification of food grains for bio fuels have resulted in shortage of food grains and, hence, price rise. So far the government has taken various measures to tackle inflation. But, even after all those measures inflation crossed the double digit. So, there is a need to ensure that monetary tightness does not affect the growth momentum.

Since last few months the discussion throughout the world has been crude oil prices and inflation. In India government gives a lot more importance to WPI inflation figure. This year the inflation figure has broken all the records. It has touched a new high since last few years. It is argued that inflation this year is imported. To say in simple way, crude oil prices are pushing the inflation to record heights. India’s import of crude is almost 70 per cent. So, it can’t do anything about the crude prices. But, yes it can try to insulate the consumers from the inflation shock.

Steps taken by Government:

Government banned exports of rice, wheat, pulses and other food articles and brought down the import duty on edible oils and other food items to zero. It also raised the minimum export price for basmati rice and maize. Moreover, it simultaneously banned the trading of potato, chana, rubber and refined soya oil in the commodity market. Last year, government had banned trading in rice, turmeric, wheat and some pulses though a year later it was found that prices still went on rising. It also allowed import of steel, iron ore and cement at zero duty. Moreover, to discourage exports of these items it imposed certain export duty. Government had also requested the cement and steel companies not to increase the prices.

At the same time, Reserve bank of India (RBI) had raised the Repo rate and CRR. This was done to tighten the liquidity in the Indian market. But, raising interest rates mean curbing the demand. If the demand is curbed then there would be a slow down in the growth. So, many analysts already feel that these steps have already affected many sectors.

Can inflation be tamed?

Yes, it can be with proper planning and policies. Oil prices have risen with sudden pace not because oil consumption has increased considerably. It has increased because the speculators have become more active in oil futures. Banning speculation in futures trading will not help. What we can do is that we should allow our rupee to appreciate against dollar. If rupee becomes stronger then the price of oil for Indian company will be lower. This step will affect exports especially from the IT sector an textiles. But, government can help exporters through various ways.

Government should focus more on better supply management of food grains and other essential commodities. According to Centre’s fourth advance estimates for crop production, the country’s total food grain production in 2007-08 (June-May crop year) is pegged at an impressive 230 million tonnes; wheat alone accounting for 78 million tonnes. Rice production is estimated to be 96.34 million tonnes which is almost one million tonnes over the 95.6 million tonnes estimated in April. Hence, the most critical task for the government is to strengthen its public distribution system and creating a better infrastructure for storing the food grains.

To curb inflation, RBI has taken various monetary steps like increasing CRR and Repo rate. This is affecting the growth of the Indian economy. Therefore, instead of rate hike RBI should allow the rupee to appreciate by releasing more dollars in the economy. A stronger rupee is a bigger tool to fight against inflation as imports of crude oil and other essential commodities like pulses become much cheaper. At the same time, government should try to curb the speculative activities by merchants, traders and middlemen through better supply chain management of food grains and improving public distribution system.

Energy consumption should be brought down. We consume three times more energy, as a percentage of GDP, than the world average. This can be done through various means. A study has shown that the energy required for agriculture pumping is drastically reduced if the groundwater table is raised. Railways consume only one-third of the energy needed to move things to places as against road transport. Water transports consume even less. Therefore, government should focus on building infrastructure in this regard so that we start using these alternatives more frequently. Also, energy from non-oil sources should be developed. The private sector should be encouraged to use more renewable source like solar, wind, waves, tides, hydro and biomass to generate energy.

We lack good infrastructure. If infrastructure improves, the cost of goods and services comes down. Hence, government should quickly build highways, power plants and ports.

Centre for Monitoring Indian Economy Private Limited (CMIE) estimates the expected inflation for this year at around 5.5 per cent. This estimate is based on the expected good monsoon and overall good kharif crop. The food situation problem should not be a long-term problem. Higher prices will induce farmers to increase their produce. But, government will have to take care as higher prices do not always reach farmers. So, government must create conditions where farmers are able to sell their produce directly to consumers so that both can benefit.

Should Rupee be allowed to appreciate?

Normally, currencies appreciate when the economies are doing well and the rise in their values is a cause for celebration. It is in India’s interest to allow rupee to appreciate to a certain level. This will pave the way for further liberalization of capital flow. India’s long term objective should be to allow free flow of international capital to further deepen the capital market.

With the oil prices touching a new level every day, it is high time that RBI does a rethinking on this front. India imports almost three-fourth of oil which drastically impacts the imports bill thereby affecting the balance of payments.

There are two views on this issue. Those who are against rupee appreciation argue that if rupee is allowed to appreciate further, then exports will be crippled. Exporters are already finding it difficult to match the competition from China especially in textiles. Any further appreciation and the industry may be shut down.

The IT sector which is making the most noise against rupee appreciation should have realized by now that their phenomenal growth during the last decade was due to rupee depreciation. But Indian economy apart from IT needs huge funds for infrastructure development. A big chunk of funds will have to come from abroad.

Those for the appreciation believe that foreign investment is essential to accelerate growth. India is a story now and it is bound to attract foreign capital owing to its strong economic fundamentals. If offshore capital flows drive up the currency, so be it. RBI should not intervene to stop currency appreciation. It will only flood the market with rupees.

Inflation is another concern for the RBI as well the government. A cheaper dollar means cheaper imports and lower inflation. Only a few weeks back, inflation was quite under control. But with the depreciating rupee, inflation has crossed beyond 5% which is the tolerance level for the RBI. Rising rupee is good news for the oil companies as they are already under tremendous pressure due to volatility in crude prices.

Therefore, rupee appreciation should be viewed in the broader context of its impact on the economy as a whole. The appreciation of the rupee has helped in bringing down the country’s import bill particularly that of oil imports which easily accounts for more than a third of all imports. This in turn helps the country in bringing down the trade deficit. Industry will be able to source its inputs from abroad at a cheaper price and hence can export more. Indian companies should learn to live with rupee appreciation and try to exploit it to the hilt.

Thus, rupee appreciation is good for economic health of our country but it carries certain demerits. But these demerits can be removed by the intervention of the government with certain favourable polices. Some of the steps that can be taken are reducing export duty for the exporters and waiving off the custom duty.