Already, inflation is resulting in the government taking steps that don’t seem logical. The Finance Minister has for long been cheering the growth story and cautioning the central bank taking any monetary steps, which might hit growth. And, he has helpfully been ‘requesting’ public sector banks not to increase interest rates, for good measure. Though the RBI is an autonomous body, the pressure on it to ignore the warning signals of rising inflation was evident.
The government may now have reason to regret its approach. The FM has released a statement on Saturday on inflation. The gist of the statement is that inflation is mainly due to rising crude oil prices and the other categories, food and manufactured products have not really risen that much. That’s on a week-on-week basis, while on a year on year basis food products are costlier by 6.8% and manufactured products by 9% (www.eaindustry.nic.in for more information).
These categories have equally contributed to inflation, even though they may not have risen over a week ago. Moreover, when fuels become expensive they have a lagged effect on other items in the economy. Power becomes expensive which in turn makes manufacturing more expensive. Freight rates will go up. Administrative costs like travel will rise. Expensive diesel will make farmers seek higher prices for their produce.
The ripple effect will be seen after a few months. The FM has met the prime minister and the RBI governor. The government will use its wheat and rice stocks to supply to the public distribution system and even supply to the open market to keep prices in check. Last week, it also announced a plan to distribute 10 lakh tonnes of edible oil through the PDS, with a subsidy of Rs 15/kg. This will cost the government Rs 1,500 crore in subsidies.
But these are tame measures compared to what a government under siege, with elections in sight can do. So expect tougher measures over the next few weeks, even if they seem illogical, as the government will need to be seen as doing something to quell inflation. Simply saying that things will settle down by October will not be enough; the media is going to whip up the government’s failure to keep inflation under control. These measures will come at a time when industrial growth is slowing down.
Excise collections grew by just 4.4% YoY in May 2008. Since excise is a tax on production, a lower growth in excise can be taken as an indicator of industrial production during the month. April 2008 infrastructure index growth slowed down to 3.6% compared to 5.9% in the previous year. While overall growth numbers on an annualized basis still look respectable, any measures taken by the government and RBI to rein in inflation can add to the slowdown being seen in recent months.
That only points to tougher times ahead which has made the stock markets jittery. So far corporate performance has not really taken a big hit, corporate tax collections in the first two months have risen by 68%, an indication that companies are profiting, irrespective of inflation or maybe because of it too. If output slows down further due to efforts to subdue demand, it may begin to hurt though. Indian companies have been profiting from a revival in pricing power, another word for inflation. But they may begin to get hit by a reduction in purchasing power, another word for an economic slowdown.