Inflation and Fuel Subsidy – An Analytical Prediction Jun24


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Inflation and Fuel Subsidy – An Analytical Prediction

Inflation-Manan Vyas

Food Inflation continues the North ward spiral with latest figures revealing inflation to be at 17.56%
RBI seeks to coordinate the fledging growth with monetary and fiscal policy.

As food inflation rises at alarming rates the RBI walks a tightrope between tightening credit policy and the nascent recovery. At the quarterly credit policy review the RBI increases the CRR by 75 basis points (0.75%) rather than the expected 50 basis points. The RBI however leaves the repo rate unchanged though it was expected to be increased by 50 basis points. The current inflationary situation however is supply side based, affecting the Consumer Price Index. The credit policy however has a larger impact on the Whole Sale Price Index (WPI). The CRR rise shall phase out Rs 36,000 crores ($7.2 billion) worth of liquidity from the system. The RBI has further initiated a phased rollback of fiscal expansionary policy by increasing the Statutory Liquidity Ratio to the pre-crisis level of 25% from 24%. Stronger inflationary measures may however damage the recovery.

Food inflation is however being joined by wider system inflation driven by demand side factors as expansionary factors work their way through the system. The RBI must coordinate the fiscal and monetary policies to achieve the fiscal deficit target and yet keeping the stimulus in place to allow the recovery to strengthen. However increasing global commodity prices, principally crude oil prices are threatning to affect the fiscal deficit and the Wholesale Price Index. The Kirit Parikh Committee recommended a drastic increase in the prices of the primary petroleum products. While petrol and diesel must be be allowed free pricing the kersosene subisdy must be decreased by Rs 6/litre and LPG subsidy be decreased by Rs 100/litre according to the recommendations of the committee. While these recommendations are too drastic as short term measures the 6th February Chief Minister’s Meeting with the PM may see a price hike of Rs3/litre in petrol and Rs3-4/litre in diesel. This shall reduce the fiscal deficit pressure on the government and allow the oil companies more headroom to increase profit margins , but it shall lead to a dramatic increase in the wholesale price index. To service the fiscal deficit target without jeopardizing the WPI the government must fast track the disinvestment programme as the increased cash flow situation shall allow it postpone increases in the basic crude commodities that have amongst the highest weightage in the WPI.
While the current growth in the WPI is demand based showcasing the positive impact of the exapansionary fiscal policy the global oil prices threaten to turn the WPI growth into a supply side inflation that shall lead to decceleration of industrial growth that is presently the highest in 18 months. It is therefore essential to postpone increases in the petroleum prices till industrial growth recovers fully.
Increasing the rates shall not help the problem as it will increase bond yields and will increase the interest payement on debt thus further affecting the fiscal deficit position. Thus keeping the growth, the WPI and fiscal deficit in mind it is essential for the central government to accelerate the disinvestment process that shall allow the Union government to maintain commodity prices at current levels leaving the industrial based inflation constant at the current 8.5% year on year.

In the meantime however the Union and State Government must act in coordination to increase the supply of essential grains in the country. To combat the supply side inflationary pressures the government must actively mobilise the Public Distribution System and release the grain supplies into the open market. Sharad Pawar has said that he believes that the inflation is supply side based and that credit policy shall have little impact on the Consumer Price Index, he believes the Chief Minister’s Meet shall be crucial. The annual budget may see an increased allocation for the farm sector, rural infrastructual developement and tax incentives to food processing industries with the aim of increasing supplies in the long term. In the year 2008-2009 Rs 58,000 crores of agricultural food items were affected by infrastructure deficit.

In conclusion the RBI and the Union government need to coordinate the priorities of industrial and wider based GDP growth with comparision to the supply side food inflation affecting the common man and the demand side Wholesale Index inflation that threatens industrial recovery. Furthermore fiscal deficit and monetary policy need to be reviewed with the disinvestment programme being accelerated to augument the government expenditure on petroleum subsidy and expansionary credit policy.

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