Wednesday, June 25, 2008

Taming Inflation

India's inflation numbers last week stood at 11.05% and will most likely go up when next week's numbers are out ( Base effect + The effect of the oil price hike flowing through the system ). The government is reaching out into its 1950s & 1970s idea cupboard for solutions to fight the inflation.

The government would do well instead to think of solutions that are more appropriate for India in 2008. The two big difference between 1970 & now is
1) The public sector no longer is the dominant force in the industrial land scape.
2) The middle class has grown in size. It has a rosier outlook to the future & has mortgaged parts of future earnings to improve its current life style.

A 1970s response of price caps & increased interest rates is just going to result in shortages on one hand & an angry middle class on the other hand. A better response would be to cut the exorbitant indirect taxes that the government charges. The steps that the government should take are

1) Slash Cenvat rates for excise to 12% from the current rates of 14%/
2) Slash service tax to 12% from the current 12.5%
3) Remove the cess on excise & service taxes
4) Move petrol & diesel to "declared goods" list , and let the oil companies price it at market driven prices

With these measures the inflation worry will disappear and will be replaced by the "Where will we find the money for all our pet schemes" worry. The excise cut impact will most likely be offset by rising production and the already risen prices ( i.e these measures will stop the further rise of prices, but are unlikely to roll them back, so excise duty would any way be higher than what the government had budgeted).
For the tax losses to the state government on petrol & diesel, the central government could hand over the oil bonds that it has been paying the oil companies.

Will the centre follow this approach ? From the RBI action yesterday ( raising CRR & Repo rates by 0.5%) it looks like the Government continues to live in the past. Will RBI at least be sensible this time by letting the Rupee appreciate against the Dollar( or better still force the rupee appreciation by dumping the enormous quantities of fast depreciating US Dollars that it owns ?) . We will have to wait and see.

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