What goes up neednt come down

Written by Bibek Debroy | Updated: Apr 1 2008, 04:52am hrs
The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation. That was Vladimir Lenin. For the week ending March 15, WPI-based point-to-point inflation is 6.68%. For a broader period, CPI-UNME (urban non-manual employees) inflation was 5.2%, CPI-IW (industrial workers) inflation was 5.51%, CPI-AL (agricultural labourers) inflation was 6.38% and CPI-RL (rural labourers) inflation was 6.11%. This may be too sweeping a statement, but in general, inflation in 2007-08 is lower than in 2006-07. The WPI and various CPIs are all indices. They involve the choice of a basket of commodities, assigning weights to them and a process of aggregation. If perceptions of inflation are sometimes higher than what these indices show, thats because ones subjective basket of commodities (and their weights) may be different from what these indices use. Thats neither here nor there. However, there is a valid point that we need to revamp and develop a new CPI, with better quality data and a more representative basket. In its absence and because of time-lags in getting information on existing CPIs, one uses WPI as a fallback option. In broad terms, 22.02% of WPIs weightage is primary articles, 14.23% is fuel, power, light and lubricants and 63.75% is manufactured products.

Going by the March 8, 2008, WPI data, the simple facts are as follows. Prices of primary articles have primarily increased because of higher prices for pulses, edible oils and fruits and vegetables. Prices of fuel, power, light and lubricants havent increased that much, essentially because higher petroleum product prices havent been passed on. Prices of manufactured products have increased because of edible oils again and metal and metal products. Manufactured product inflation is easy to blame. But individually, barring the items just mentioned, manufacturing inflation hasnt been that high. However, collectively, because of high aggregate weight, manufacturing contribution to inflation is high.

Lets take another general point. In a globalised and integrated world, prices will tend to equalise. Except some items, pre-1991, agro prices were lower in India than globally. And manufactured prices were higher in India than globally. With reforms, one expects domestic agro prices to increase and domestic manufactured prices to drop. Logically, one cant accept the drop and refuse to accept the increase. How fair is it to ban exports of wheat, pulses and even edible oils and deprive farmers of possible higher incomes This is a permanent, rather than temporary, issue.

Forget crude oil and focus on global prices of edible oils, food-grains and metals. Incidentally, Indian inflation in these has been lower than inflation in global markets. Some transient shocks have contributed to increases in prices of these items. However, there are more permanent upward pressures, driven by higher growth and increased demand. There is inevitability about accepting higher global prices of energy, edible oils, food and commodities.

Kneejerk reactions that treat this as a temporary crisis miss the point. The response has to be generic, including recognition that the rupee must be allowed to appreciate. One should also look for generic responses in domestic agriculture. Pulses are a case in point. Where in the world are we going to import pulses from Why are productivity levels in Indian agriculture low and yields stagnant Why do inordinately long distribution chains create such an undesirable gap between farmgate prices and retail prices Why arent forward markets allowed to smoothen volatility The inflation bogey could have been used as a trigger to catalyse these changes, since they werent happening otherwise. In the same vein, for manufactured products, why not remove bottlenecks that constrain supply-side adjustments

Instead of generic responses, we resorted to ad hoc kneejerk reactions, like tinkering with duties. Take domestic indirect taxes first. There is an eventual target of a unified GST (goods & services tax) rate of 14%, or perhaps 12%. Why should one deviate from this tax reform agenda and introduce tinkering because of the inflation bogey Whats given away in some manufactures, through rate declines, is actually more than neutralised in what is taken away in some services. And would have been captured better had the WPI (or CPI) had more representative weights for services. Import duty cuts are different, since tariffs should move downwards, regardless of what happens at the WTO. But the duty cuts on edible oils (or rice) are too small to make much of a dent.

Restated differently, three statements should be self-evident. First, inflation in the 5-6% range is inevitable, an election year notwithstanding. Second, suppression of inflation manifests itself in other problems, the petroleum sector being a case in point. Third, the poor (not the bourgeoisie) suffer the most, because their incomes arent inflation-indexed. Inflation is a regressive tax. But the answer to that is to target and subsidise the poor, not subsidise everybody. Thats what an aam aadmi-fixated government should have tried to do.

The author is an economist. These are his personal views