We have import tariffs that are much higher than those of the Asian economies who we seek to join through free trade agreements. Import tariffs for intermediates have gone up since the mid-1990s. Undoubtedly, thinking in official circles was that the pain of eventually reducing the tariffs would be largely offset by continued depreciation of the rupee. Government never quite got around to reducing tariffs (unpopular with business) and the assumption on the rupee was greatly in error. So, as is always the case, procrastination is set to exact a heavy price. We are now faced with the difficult job of bringing import tariffs down, while the rupee is set to either hold value, or further strengthen.
In this context, higher domestic inflation is terrible news. Through 2003, wholesale price (WPI) inflation has averaged 5 per cent, compared to below 2 per cent in developed economies and lower still in many Asian countries. In the same period, the rupee gained 5.7 per cent against the US dollar, which is particularly material, since many key Asian currencies move with the dollar. The double whammy was further compounded by the fact that WPI inflation this year has not been due to either energy or food price spikes that tend to be volatile and temporary, but has come from inflation in manufactured goods, which tend to be permanent. Further, manufactured goods are precisely where reduction of import tariffs is likely.
But have prices of all manufactured goods gone up by 5 per cent? If so, it would undoubtedly have been great news for corporate profits, and a terribly bad one for the cost of realigning import tariffs. This calendar year, WPI inflation rose sharply to touch a peak level of 6.9 per cent for the week ending 3 May; it eased subsequently to 3.8 per cent on 23 August and since then again risen to breach 5 per cent in late September. Inflation in manufactured goods rose to 5 per cent in early May, easing thereafter to 4.1 per cent in the week ending 2 August. But it has again risen to 5.26 per cent for the week ending 25 October 2003, noticeably a rate that is higher than the overall rate of 4.96 per cent.
First, as far as overall inflation goes, two agricultural raw materials have really helped work things up. Raw cotton saw inflation of 38 per cent on 3 May, while for oilseeds it was 27 per cent. Between the two, they accounted for 1.23 percentage points of inflation. That is, inflation would have been 5.7 per cent, not 6.9 per cent, but for cotton and oilseeds. On 2 Aug, inflation in cotton was 23 per cent, but it came down to 10 per cent for oilseeds, the trend continuing on 25 Oct, with 28 per cent for cotton and 6 per cent for oilseeds.
Then to manufactured goods. Only four items ? edible oil, cotton textiles, tea & coffee and iron & steel? have been driving prices up. Edible oil saw inflation rates of 27, 16 and 12 per cent as on 3 May, 2 Aug, and 25 Oct. Cotton textiles was another major contributor with rates of 9, 7 and 10 per cent as on 3 May, 2 Aug and 25 Oct. Given weak auction tea prices it might come as a surprise that prices of packaged tea and coffee have risen by 26 per cent through this year. This is due more to the terribly weak prices in 2001, than to excess demand this year. Then comes the single biggest contributor to inflation this year: Iron & steel which reported inflation of 19, 15 and 29 per cent on 3 May, 2 Aug and 25 Oct, contributing as much as 1.05 percentage points to overall inflation. In sharp contrast to these four items, all other manufactured goods show inflation in the range of zero to 3 per cent.
The fact that inflation has touched so few items indicates that it will ease in the near future. Then, domestic inflation has not raised the cost of tariff realignment, at least as of yet. Further postponing tariff reductions will just make the eventual adjustment costs much higher.
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)