State-sponsored inflation: Economic Times: 18th July 2008

Inflation is becoming progressively a major concern since the number has reached crazy heights; and the more pessimistic ones are already likening this situation to the pre-reforms crisis phase. All possible options have been explored to tackle inflation. The CRR and repo rates have been relentlessly raised. Imports have been liberalised and exports curtailed. Stock limits have been applied for essential commodities. Tariffs have been reduced and even futures trading in some commodities have been banned. Yet, there seems to be no respite from inflation, which has been driven by fundamentals as well as global factors. In this milieu the role of government has escaped attention. The purpose here is to examine the possible inadvertent part played by the government in fuelling inflation, which may be called ‘state-sponsored inflation’. Government here should not be interpreted as the existing or past governments, but simply as the entity which runs the country and has economic policies to support its functioning. The approach is from the theoretical angle and there are no political undertones as this would hold good for governments anywhere in the world. The government comes into the picture several ways. To begin with, it controls the prices of several essential goods comprising the wholesale price index (WPI). There is the MSP (minimum support price) which is announced for several crops every year, at the time of sowing. The idea is that the farmers should be aware of the price to be received at harvest time. It is calculated by the Commission on Costs and Prices (CACP), which determines the price based on several parameters such as price last year, cost of cultivation, cost of living, relative prices of other crops, etc. This is fixed for all major crops including cereals, pulses, oilseeds and fibres. It is active mainly in rice and wheat and to an extent in cotton and sugarcane. But, this sets the tone for prices in the market as a floor is set by the government itself. Curiously, today the build up of excess buffer stocks when production has peaked has created a shortage in the market for foodgrains as prices are increasing. Now, products such as rice, wheat, cotton and sugarcane have a weight of 6.79% in the WPI and directly enter the inflation basket. So, when the MSP of rice or wheat is increased, one may expect the inflation numbers to move upwards. If others like coarse cereals, pulses and oilseeds are added, then the weight goes up by 3.89%. For the last season, the MSPs of paddy, bajra, maize, ragi, arhar, moong, urad, masoor and barely were raised by over 10%. Intuitively, one can guess the impact on inflation. Therefore, in the agri-sphere, one can say that 10.68% of the 22.03% weight of primary articles has a strong government influence. The entire mineral oils group which has a weight of 6.99% is dormant as long as the government decides not to change their administered prices. But, the moment it does, then the prices for the entire group moves up by varying degrees. This component is nearly 50% of the entire group of fuel products in the WPI. Here the government faces a conundrum. If fuel prices are not raised or the MSP is increased, then the subsidy bill goes up, pushing the fiscal balances into jeopardy. If the government adjusts fuel price, then inflation goes out of hand. In fact, while the direct impact of fuel prices is 6.99%, the indirect effect is even higher as fuel products go as feedstock into products such as fertilisers, pesticides and other chemicals which in turn add to the cost of cultivation. Also as transportation costs go up, the prices of all commodities in the WPI would move up as transportation is part of all costs of production. Hence, the indirect impact can be even more severe than the direct impact, which is hard to quantify. Within the manufactured products group, sugar (where the price is controlled partially) accounts for 3.62% of the WPI. Besides, as the SMP (statutory minimum price) of sugarcane is increased, the price of sugar goes up. The other route for state sponsored inflation is taxation. Today, total indirect taxes, which fall essentially on manufactured goods (a very small part goes on agri-products) account for around 30% of value added in manufacturing. And given that manufactured goods have a weight of 63.75% in the WPI, we are really speaking of another 19% of inflation being driven by government policy. Taxes have been moving down in the past, but, prices generally tend to be sticky in the downward direction. Also with the exception of probably the consumer goods industry, the lower tax benefits are seldom passed to the consumer. What does all this add up to? Around 21% of the WPI is directly influenced by government action where the actual impetus is provided by the state. The government has a problem here since in the agricultural sector, where farming is the only means of livelihood for workers, an increase in MSP is the only way to protect against core inflation. Since productivity is low and there is no significant increase in acreage under cultivation, farmers would slip into poverty in the absence of such increases in prices. If we add the other 19% taxation effect, the government can actually move 40% of the inflation numbers directly. The indirect impact would be hard to quantify as all components are inter-related: higher taxes on steel push up the price of automobiles, engineering goods and so on. On a conservative side, the indirect effects of all these components especially fuel and agri-products could influence another 10% of the price index. This means that almost 50% of the WPI is under the purview of the government. Hence, it can be seen that one of the dominant causes of inflation is the government and such state-sponsored inflation cannot be escaped. All these monetary policy measures or bans may just be like chasing a crooked shadow, especially since the genesis of the irksome double- digit inflation rate, ironically, lies within.