The social tug-of-war that inflation inevitably triggers
PremiumSurging prices call for tricky policy decisions on balancing divergent interests in ways that are fair
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PremiumConsumer inflation is the highest it has been in the past eight years. There is no sign of easing. Wholesale inflation is close to 16%, the highest in 27 years, and has been in double digits for more than a year. It is not as if one or two components of these indices are pushing up the numbers. Price rise is evident across the consumer or producer basket, whether it is food, perishables like tomatoes, petrol and diesel, metals, coal, cement, or rents and other services. Even telecom rates, which India once touted as the lowest in the world, have risen significantly. Those days of free data and voice seem like a distant past.
The government and Reserve Bank of India (RBI) have been trying valiantly to arrest the price-rise momentum and curb inflationary expectations. For its part, RBI abruptly hiked interest rates twice in the past two months, and more rate hikes are expected. Liquidity has been drained. The repo rate, which is decided by the Monetary Policy Committee of RBI, is one of the most important “prices" controlled by authorities. It is not market-determined but fixed by our policymakers. So is the exchange rate, which is the external value of the rupee. RBI may vehemently deny that it interferes with the market mechanism for foreign exchange rates or that it “fixes" the value of the rupee. But we know that there is significant intervention in the forex market, and for good reason. When it keeps the rupee too strong, it hurts exporters, and when it is too weak it hurts importers, including those sending tuition fees for their wards in US colleges. Similarly, if interest rates are set too low, it hurts pensioners and those depending on income from their fixed deposits, but it benefits home loan borrowers as well as the government, which is the biggest borrower in the system. Indeed, it can safely be said that roughly half of India’s fixed income depends on “prices" that are not market-determined. Thus, this “fixing" of the price of money or of foreign exchange involves balancing the interests of gainers and losers.
Many more prices in the economic system are “fixed" and not market-determined than you may realize. Consider the recent cut in excise duties on petrol and diesel. The Union government reduced these by ₹8 and ₹6 per litre, causing a loss of ₹1 trillion to the exchequer. The cooking gas subsidy was increased by ₹200 per cylinder, causing a further loss of ₹60 billion to the treasury. Whose loss is it? It might imply correspondingly less allocation to higher education, or the National Rural Employment Guarantee Scheme, or perhaps to the military. Fiscal relief for petro products means hurting another segment of society. The government also decided to increase the minimum support price of 14 crops by 6%. This is the highest increase in the past four years but is still lower than the increase in cost of cultivation of these crops. So, farmers won’t be satisfied and urban consumers will sulk too due to upward pressure on the prices of foodgrain and other agricultural products.
To assuage the fear, anger and anxiety of urban consumers, the government has banned the export of wheat, whose prices doubled globally after the Ukraine war outbreak. Poor wheat farmers and traders keen to cash in on an international price boom must be feeling betrayed. The same story is true for sugarcane farmers or sugar producers, since they too face an export ban. All these bans are to ensure higher domestic supply and keep prices down. Here too, the interests of gainers and losers clash, and the government plays arbiter.
The fight against inflation can go beyond mere price fixing, to taxing windfall profits too. The Ukraine war caused oil and commodity prices to spike, delivering big profits to producers of oil, steel and other metals and commodities. For instance, the profits of British Petroleum and Shell doubled and trebled, respectively, in the first three months of this year. Hence, the government of the UK has decided to impose a windfall gains tax on oil and gas companies, which will fetch £5 billion for the British exchequer. This windfall gains tax will be used to help poorer households deal with higher bills due to energy inflation. So, this too is an example of finding a balance between gainers and losers of inflation. In India too, as large infrastructure projects are auctioned off to contractors, the government will insist on lower prices of cement and steel, which means lower profits for those companies. There is no easy way out of inflation, but while it lasts, it benefits producers and singes consumers, and governments try to shift the balance of gain and pain to a point that is deemed fair. It’s difficult to say whether taxing windfall gains of a risk-taking entrepreneur is fair or not, but then there are no objective criteria to determine fairness. When seen as a fight for a fair balance between gainers and losers, inflation can no longer be seen merely as a purely monetary phenomenon, as postulated by Milton Friedman. It is often the result of scarcities caused not by natural phenomena, but by man-made actions like war, ill-advised policies or just human follies.
Former RBI governor I.G. Patel, quoting Edward M. Bernstein, the first research director at the International Monetary Fund, had said that ultimately inflation is as much a political phenomenon as a social tug of war between one section of society that wants a higher share of income than the other is ready to surrender without a fight. To that extent, governments cannot shy away from the tough task of finding that elusive balance deemed to be fair and just.
Ajit Ranade is a Pune-based economist
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