Wednesday, 4 May 2011

To do or not to do?

I was reading an article in the Times of India earlier today, that the Government of India is going to increase fuel prices by a further Rs. 3 one the state assembly polls will be over. Given the fact that fuel prices in India are already at a historic high, the latest development, when it happens, is only going to further fuel inflation.

Citizen unfriendly policy many might say. For sure, there will be opposition parties queuing up to take advantage of the situation to embarass the beleaguered Congress government already trying hard to combat the twin embarrasments of mounting inflation and corruption charges against cabinet ministers. There will most probably be calls for increasing fuel subsidies. Had it not been for the fact that they are themselves fighting a battle of survival, the communist parties would have been baying for subsidies now.

Truth be told, the situation is a double-edged sword. With international fuel prices in excess of $100 per barrell and going further up, there is little any government can do about the resultant cost-push inflation (for the benefit of those who do not have background in economics: cost-push inflation refers to inflation caused by rising prices of essential comodities).

To be sure, one area that merits review is the taxation policy, given the fact that most, if not all, state governments in India levy VAT on fuels- one of the well kept secrets that no one ever bothers to ever mention. In states like Maharashtra, that tax is somewhere in the region of 30%. Its hard to see how the government is going to tackly inflation as long as it taxes essential commodities so heavily (for the record, the party in power in Maharashtra is the same one which is in power at the centre).

Nevertheless, even if the tax component were reduced, the government would still have quite a job on hand battling oil price fuelled inflation. Those who argue for an increase in subsidies would do well to explain where the money for those subsisides will come from. With the government already running a massive budgetary deficit, an increase in subsidies will only aggravate the situation, resulting in substantially increased deficit financing, which will only push interest rates further up- the net result? Increased cost of financing, which will cause companies to raise the prices of their products/ services. The net effect? You guessed it right, inflation.

In short, inflation on account of rising fuel prices is inevitable. Subsidies will only delay the inevitable, but make no mistake: subsidising fuel costs is no solution for cost-push inflation.

Which way do we go then? Not being an expert economist, I for one cannot honestly claim to have a solution. But given the fact that even world renowed economists like Ahluwalia and Dr. Manmohan Singh themselves have been unable to conjure up a solution, the problem must surely be a very tricky one.

In other words, the only way ahead is to accept that inflation is here to stay and that we are just passing through a period of extraordinary inflation- there have been historic periods of high inflation before and this is the latest of them. It would be futile to blame the Government for rising prices- the cost push inflation that's sending prices skyrocketing in India is something no Government can do anything about.

The solution to this problem (insofar as there is one, since inflation is normally a short-term phenomenon) necessarily needs to be long term: identify substitutes for fossil fuels. The day India can find a sustainable alternative to imported fossil fuels, we will have a solution to fuel price induced inflation.

Until then we can only hope that international fuel prices will cool down and give us some respite from the monster of rising prices.

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