The Hindu Business Line : A global problem comes knocking on India’s doors

From Mexico to Mauritius, rocketing food prices have sparked off riots. Having integrated our economy with global trade, it is not open to us to complain about the adverse effects of globalisation. Given that the problem is on the supply side, we have to act to increase supply rather than impose price controls, says T. C. A. RAMANUJAM.

The alarm bells are ringing. Inflation is now at 7.4 per cent. This is a three-year high. The Finance Minister is right. “We have no control over inflation,” he said, “We are importing inflation.” From Mexico to Mauritius, rocketing food prices have sparked off riots.

Economists have pointed out that this is not demand-pull inflation. The problem is on the supply side. Soaring oil prices are inducing shift to bio-fuels as an alternative to hydrocarbons. This is straining food supplies. The area used for biofuels is increasing each year.

Till the other day, we were gloating about the higher levels of growth that have been achieved without much inflation. Received wisdom has it that growth and inflation go together. The past three years proved an exception to this rule. That was, in the words of a leading economist from the West, “an age of innocence.”

Price Controls

It is no consolation that we are suffering a world-wide inflation. The man in the street wants governments to act. Shall we impose price controls? What is global experience in this regard? The World Bank has listed 21 countries that have imposed controls on strategic staples; the list includes Russia, Venezuela, Egypt, Tunisia, Pakistan, Thailand, Panama and Peru. China is battling a 11-year high inflation and has introduced controls. The Peruvian President, Mr Alan Garcia, who imposed price controls earlier has chosen to withdraw the same.

World Bank Economist, Don Mitchell, cautions that price controls can reduce supplies, discourage domestic productions and induce black market operations. Instead, governments need to focus on direct subsides for the poor rather than the whole country. Income transfers or food assistance for the poor will work more efficiently than price controls.

The Prime Minister is right in rejecting price controls as an option. Governments at the Centre and in the State should, however, improve the public distribution system where rice and wheat meant for the under-privileged sections of societies are being diverted into the black market. The subsidised rice, wheat, pulses and edible oil do not reach the targeted class. Provisions of the Essential Commodities Act can be more rigorously applied to curb hoarding.

Export Bans

True to expectations, the Government has banned export of essential commodities, levied export duties and reduced import duties. These measures can be counter-productive. The interests of the consumers are no doubt paramount. But the concerns voiced by producers cannot be overlooked.

Restricting exports of food grains and other raw materials in an attempt to shore up domestic supplies may be politically expedient but such measures can be economically self-defeating.

Future access to markets at a more opportune time will be jeopardised. Export bans in one country will push up prices in other countries in the world market. A better approach would be to increase supply.

Duty cuts will no doubt be welcome, but they are not always passed on to the consumers. More than a decade ago, the Supreme Court had propounded the Doctrine of Unjust Enrichment to deal with such cases of manufacturers pocketing the duty cuts to themselves. The Government has to device a mechanism to oversee the passing on of the benefit of duty cuts to the ultimate consumers.

Rupee Exchange Rate

Are we justified in attributing inflation to global prices? “Thunder at Courtalam, lights off at Coimbatore and Tanjore,” went a Tamil Song in an old movie, “Miss Malini”. Having integrated our economy with global trade, it is not open to us to complain about the adverse affects of globalisation. In the past 15 years, exports of developing countries have doubled to 50 per cent of their GDP.

At the same time, the fact remains that Brazil, Russia, India and China are now less dependant on exports to the US than in the past.

Decoupling

Economists across the globe are wondering if these countries can afford to decouple from the global market. In an IMF working paper, “Changing nature of North-South linkages: Stylised facts and explanations”, Cigdem Akin and Aykhan Kose expound the idea that we can have both decoupling and globalisation at the same time. Growth is now more synchronised among emerging economies.

In a globalised world, everyone is in the same boat and business cycles will become more synchronised. They argue that globalisation and decoupling can co-exist. Domestic demand grew up four-fold in emerging economies in 2007 compared to the demand in the developed world.

“Act global, think local” is a new slogan. With their large foreign exchange reserves, these countries can make full use of monetary and fiscal policy to fine-tune their economies.

Over 60 per cent of the foreign exchange reserves in these countries are represented by the US dollar. Why continue to peg the rupee mainly to the dollar?

This reflects a currency board mentality. Saudi Arabia is suffering high inflation because its currency is perpetually married to the dollar. We can choose alternative exchange alignments with the euro, which is more dependable than the volatile dollar.

In the 1990s, when reforms were ushered in, the then Finance Minister put the foreign exchange reserves to good use by bringing in the Millennium bonds and the India Resurgent bonds.

Banks were able to make advances for infrastructure projects on the strength of these bonds. Nobody has now thought of putting our huge foreign exchange reserves to active use. In inflationary times, the foreign exchange reserves can be utilised for subsidising oil imports and reducing prices.

Expansionary Budget

We have to admit that it is not external forces alone that are responsible for the present crisis. Budget 2008 chose to follow an expansionary fiscal policy. Doubling of the basic tax exemption limit led to expectations of large cash on hand from April 2008 onwards leading to pressure on prices.

The introduction of Commercial Transactions Tax will certainly push up prices on commodity exchanges. The tax will increase the transactions costs of exchanges to Rs 21 from the current Rs 3.

This fear of commodity exchanges needs to be addressed. These exchanges trade in edible oils, oil seeds, pulses and the like. The CTT should be withdrawn.

We have lived with inflation rates of 13.7 per cent in 1991-92, 10.1 per cent in 1992-93 and 12.6 per cent in 1994-95. With an Economist Prime Minister at the head, we will certainly overcome the present crisis successfully.

(The author is former Chief Commissioner of Income Tax.)