People's Democracy(Weekly Organ of the Communist Party of India (Marxist)
September 26, 2004
C P Chandrasekhar
is clearly a cause for concern for the UPA government. Among the few economic
policy initiatives it has taken in its less-than-four months in office, efforts
to rein in inflation dominate. The reason: As on August 28, the point-to-point
annual rate of inflation as measured by the Wholesale Price Index (WPI) stood at
8.33 per cent. The climb to that figure has been consistent, starting from 4.2
per cent on an annualised basis on May 1.
other than an effort to squeeze liquidity by raising the cash reserve ratio, the
government’s anti-inflation drive has focused on individual commodities such
as oil, steel and sugar. This is because the evidence indicates that the
inflationary spurt is in large part accounted for by a few commodity groups.
Specifically, the sharp rise in the inflation rate is attributable to fuel,
primary articles and steel, with sugar playing a small role as well. At the
beginning of May this year, this set of commodities contributed a total of 2.7
percentage points to the 4.2 per cent inflation rate. By August 21, they
contributed 5.2 percentage points to the 8.2 per cent inflation rate.
throughout the period of the inflationary spurt, these commodities accounted for
between 63 and 71 per cent of the annualised inflation rate computed every week.
In fact, even the residual one-third of the inflation rate is in part
attributable to some of these commodities.
These commodities, especially oil and steel, enter into the costs of production
of a range of others, with oil being in the nature of a universal intermediate.
Hence, any increase in their prices has second-order effects that translate into
a more generalised inflation. The sharp increase in oil and steel prices
relative to the corresponding period of the previous year would have raised the
costs of production and therefore the prices of all commodities, including those
that are implicitly being categorised under the residual ‘Others’ category
in this discussion. Thus, any assessment of the factors underlying inflation has
to focus on the factors explaining the rise in the prices of this set of
in these terms, the current inflation appears to be substantially driven by
external factors, since domestic inflation in oil and steel is obviously driven
by international price trends.
In the case of oil, a host of developments varying from the war in Iraq, the
troubles in Venezuela and the controversies that dog the Russian oil industry,
have ensured that prices continue to rule well above the $40-per-barrel level.
Given the much lower levels at which oil prices prevailed during the
corresponding months of the previous year, the figures yield a high annualised
increase in international oil prices.
prices too have been buoyant for a long time now. Global steel prices rebounded
sharply in 2002 from a 20-year low the year before. Since then they have been
buoyant, sustained by a surge in demand from China. In 2003, the sharp rise in
consumption in Asia and particularly in China had helped offset stagnation in
the west and brightened the outlook for the leading steel producers in Europe,
Japan and the US, which had otherwise been cutting production in order to
support prices. They had by then opted to exploit the strong market with higher
margins that spelt high profits.
then demand in China has remained strong despite expectations that it would
taper off. According to the International Iron and Steel Institute (IISI), the
world’s steel demand is forecast to swell to 917 million tons this year,
breaking through the 900-million-ton mark for the first time. Chinese demand for
steel products is predicted to reach 263 million tons in 2004, accounting for 29
per cent of the total global demand. With China’s high steel consumption
expected to last, global steel demand is projected to grow at an annual average
of 4.6 per cent, reaching 1.04 billion tons in 2007. In the event, international
steel prices are expected to keep their uptrend even after 2005 encouraging
producers to raise their mark-ups and keep prices rising.
developments in the international economy have impacted India adversely because
the government’s liberalisation policy has either consciously sought to link
domestic prices to world prices or trade liberalisation has ensured that
international prices drive domestic prices in the country.
Prior to the repeal of the administered pricing regime in oil, the domestic
price of the commodity was considered one of the instruments of the
government’s tax-cum-subsidy regime. When international oil prices fell but
domestic prices were stable, the oil companies accumulated surpluses through an
implicit tax on consumers, which were available for investment purposes or were
transferred to the government’s budget. On the other hand, when international
oil prices ruled high, the oil companies incurred losses which had to be either
implicitly (through finance for expenditures) or explicitly be subsidised by the
government through its revenues from elsewhere. The repeal of administered
pricing has meant that fluctuations in global oil prices directly impact the
OF OIL AND STEEL
OIL AND STEEL
the case of steel, matters are slightly different. Prior to steel price
decontrol, domestic prices were fixed at a level that covered domestic costs of
production and offered producers a reasonable rate of return. But even after
decontrol, any tendency for the prices of the metal or its products to rise
excessively because of buoyant market conditions was implicitly controlled,
because of the strong presence of the public sector in the industry and the
strong arm of the government in the public sector. Liberalisation has changed
all that. In the wake of internal liberalisation domestic producers, including
the public sector, are free to set prices depending on what the market would
bear. And with restrictions on imports and exports removed under the liberalised
trade policy, what the market would bear has come to be determined by the level
of global prices. International supply and demand balances determine domestic
steel prices as well.
could be argued that given the high share of imported crude and oil products in
domestic consumption, some link between domestic and international prices is
inevitable, if the government is not to be subsidising oil consumption
But the same argument can hardly apply to steel where domestic prices have risen
sharply despite the ability of the domestic industry to meet domestic demand.
According to official sources, the domestic price of hot-rolled coils had
increased to Rs 29,875 per tonne in May 2004 from Rs 20,500 per tonne in January
2003 and Rs 15,500 per tonne in January 2002.
Similarly, the price of cold-rolled coils had risen to to Rs 34,300 per
tonne in May 2004 from Rs 26,000 per tonne in January 2003 and just Rs 19,500
per tonne in January 2002. Cost increases do not explain the price spurt, which
has resulted in huge profits for the steel producers.
sum, India’s dependence on imports of crude and her integration into the
world steel market, combined with a more market driven pricing system, has
contributed in substantial measure to the current rate of inflation. The net
effect is that in the case of both oil and steel liberalisation has meant that
global trends have resulted in sharp increases in domestic prices as well.
These price increases have resulted in these commodities contributing as much as
1.5-1.7 percentage points each to the 6-7.5 per cent rate of inflation between
mid-June and early-August.
price increase has been partly moderated through a reduction in duties imposed
on petroleum and petroleum products. But so long as the view that domestic oil
prices should keep pace with international values prevails, there are limits to
which the domestic inflation rate can be insulated from the effects of
international oil price trends.
OVER THE MONSOON
this has been combined with an indifferent and uneven monsoon that was delayed
substantially in many parts of the country. While this is not expected to result
in agricultural output shortfalls of the kind witnessed in 2002-03, production
is not likely to equal that in 2003-04. Fortunately,
given the current food stock position this would not result in any imbalance
between demand and supply. However, the uncertainties over the monsoon have
provided the basis for speculative price increases in the case of a number of
primary commodities, resulting in a significant inflation in the wholesale price
indices for Primary articles. As a result this too has contributed to the sharp
rise in prices.
in the case of sugar, a decline in production over two years has resulted in a
significant fall in the level of stockholding. This has triggered a price
increase, fuelled by speculation, even though international prices in this case
have been subdued.
congruence of this set of factors explains the return of inflation, which once
again is grabbing headlines. It must be said that, compared to its lethargy in
most other areas, the government’s response on this front has been quick and
varied. This response has included duty cuts on petro-products and steel, a
50-basis-points hike in the cash reserve ratio and relaxation of the norms with
regard to sugar imports. Raw sugar
imports are now allowed duty-free with the obligation to export from domestic
production within 24 months. In the case of steel, the government has also
sought to deal with this problem by forcing domestic producers to hold and even
cut their prices.
the response is three-fold in nature. First, it attempts to moderate the effects
of global price movements on domestic inflation by making compensatory
reductions in domestic duties and persuading domestic suppliers to hold their
prices. Secondly, it attempts to dampen speculation by reducing liquidity in the
system through measures such as the hike in the cash reserve ratio. And,
thirdly, it seeks to reverse domestic price increases by facilitating larger
of these is likely to be effective enough to deal with the problem. The problem
is that, in the wake of liberalisation, the government has left itself with few
options to deal with situations like this. Duty cuts can only be carried to a
limit, and in any case worsen the government’s already weak fiscal position.
The use of monetary levers is ineffective and already under attack from industry
because it could push up interest rates. And imports are not an effective option
since it is international prices that drive domestic inflation in any case.
long as increases in the international prices of oil and steel persist and the
link between domestic and international prices is not sought to be directly
broken, measures such as duty reductions can only serve as short-term and
partial palliatives. It is also unlikely that half-hearted measures to reduce
liquidity can make any difference to speculation. And, finally, easier imports
can make a difference only in the case of commodities like sugar and edible
oils, in whose case international prices are subdued. But their contribution to
the inflation rate is the least. Hence, unless there is
a change in policy stance, inflation is likely to persist so long as
international prices of oil and steel remain buoyant and the base for
speculative price increases in primary commodities exists.
danger is that this inflation driven by international price trends and
speculation rather than by demand supply imbalances would provide an argument
for further fiscal contraction, even though food stocks, foreign exchange
reserves and unutilised capacity warrant an expansionary fiscal stance. If that
happens, the still slow progress on implementing the National Common Minimum
Programme would soon be halted.