There’s a simple theory about why Narendra Modi was elected prime minister, and it has nothing to do with Hindutva or the 2G spectrum scandal: it’s the inflation, stupid.
While price rise alone might not explain the historic nature of this election result, there’s no doubt it played a huge role in turning ordinary people against the government. Which means Modi should be thanking his stars that he doesn’t have to face an election any time soon.
A combination of external factors, like the poor monsoon so far and some difficult but necessary economic measures, means Modi could be staring at an inflation rate that remains as stubborn as it was in the United Progressive Alliance years.
In addition to reflecting negatively on Modi’s government, which included tackling price rise as the first item of the first section in its election manifesto, it also means that any hope of reducing interest rates might have to be put off for now.
That's why Modi was forced to call a meeting on Thursday asking for closer cooperation between the Centre and states, requesting them to set up fast-track courts to check hoarding and to use the Mahatma Gandhi National Rural Employment Guarantee Act to generate employment. But all of that might not be enough. Here's a look at why inflation will continue to remain stubbornly high.
External Factors
* Weak monsoon and food prices
No matter how much India has tried to wean itself off agriculture, the litmus test of the country’s economy remains the performance of clouds passing through between June and September. So far, the signs aren’t good.
India faces the weakest start to the monsoon in five years, with rainfall 38% below a 50-year average since June 1. While this may change as the clouds move north, the delay alone means crop areas might end up being smaller and yields could fall. Japanese brokerage firm Nomura, projecting from the current forecast, estimates year-on-year agricultural growth in the financial year 2014-15 to fall to just 0.8%, down from 4.8% last year.
That would, almost automatically, mean higher food prices. Rates of onions have already shot up, while other vegetables are also getting dearer. Unless the rains improve, things are unlikely to get any better.
The government has already taken quite a few steps — offloading rice stocks, minimum export prices for onions, calling on states to crack down on hoarding — but there is only so much it can do if the rains don’t come.
* Oil prices
Iraq is in the midst of a violent civil war, with no clear solution to the problem in sight. India imports more than 500,000 barrels of oil from Iraq every day. Those two sentences put together should be giving sleepless nights to Indian policymakers. In fact, even if India didn’t import so much crude from Iraq, it would still be concerned about events there, since it happens to be the second-largest producer of oil among the OPEC nations and a key indicator of what oil prices ought to be.
HSBC’s estimate suggests that a $10 per barrel increase in the price of crude oil would push up wholesale inflation by a full percentage point over 12 months. Although prices have stabilised somewhat, with Reserve Bank of India Governor Raghuram Rajan insisting that he will be keeping close watch, news that the US might be about to intervene in some form in Iraq yet again does not bode well for the oil market.
Government decisions
* Sugar subsidies
Modi’s small government mantra might remind you of conservative parties everywhere, particularly in the US, but that doesn’t mean it has embraced every tenet of conservatism. Protectionism, for example, still has its place in Modi sarkar.
The government – most likely keeping the upcoming Maharashtra election in mind – has decided to retain the export subsidy of Rs 3,300 per tonne of raw sugar, which the UPA had put in place, and massively increased the import duty on the sweet stuff from 15% to 40%.
The government wants to improve the profitability of sugar mills, which are believed to owe farmers around Rs 11,000 crore, but this is projected to lead to a rise in sugar prices by up to Rs 2 or 3 per kilogram. With sugar and related projects having a weightage of nearly 3% in the wholesale price index, it is likely to have a direct impact on overall inflation.
* Off the rails
It may have been partially rolled back – also with Maharashtra in mind – but any increase in freight and passenger costs on the railways ends up having an effect on inflation. The decision to implement across-the-board increases in fares ended up not directly impacting city commuters after the government decided it wouldn’t apply to journeys of up to 80 km on suburban trains. But the hike of 14.3% in passenger rates and 6.5% in freight fares remains.
“The rise in passenger fares will add around 10 basis points to CPI inflation, while there will be a limited indirect impact on the CPI from the freight hike,” said Nomura, the Japanese brokerage firm. “WPI inflation is likely to see a marginally larger impact as the cost of transporting goods such as coal, cement, oil, steel and food grains will rise.”
* Gas trouble
This is the clearest sign yet that the government, despite promising bold measures and bitter pills for the betterment of the economy, is afraid of the monster of inflation. This week, the oil minister announced that any revision of gas prices from the current $4.2 per mBtu will only happen after three months, defusing both the potentially problematic political fallout of any increase as well as its inflationary effects.
Every dollar increase in gas price adds Rs 1,370 per ton in urea production costs and 35 paise per unit increase in electricity tariffs, in addition to increasing CNG and piped cooking gas costs, according to The Hindu. Expected changes to the rate seem to extend from $6 per mBtu to $8 per mBtu.
Not increasing costs, however, means revenues for the year will be significantly impacted, leaving the overall fiscal picture in a problematic position. For now the government isn’t allowing gas prices to add to overall inflation, but it won't be long before it has to bite this bullet too.
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While price rise alone might not explain the historic nature of this election result, there’s no doubt it played a huge role in turning ordinary people against the government. Which means Modi should be thanking his stars that he doesn’t have to face an election any time soon.
A combination of external factors, like the poor monsoon so far and some difficult but necessary economic measures, means Modi could be staring at an inflation rate that remains as stubborn as it was in the United Progressive Alliance years.
In addition to reflecting negatively on Modi’s government, which included tackling price rise as the first item of the first section in its election manifesto, it also means that any hope of reducing interest rates might have to be put off for now.
That's why Modi was forced to call a meeting on Thursday asking for closer cooperation between the Centre and states, requesting them to set up fast-track courts to check hoarding and to use the Mahatma Gandhi National Rural Employment Guarantee Act to generate employment. But all of that might not be enough. Here's a look at why inflation will continue to remain stubbornly high.
External Factors
* Weak monsoon and food prices
No matter how much India has tried to wean itself off agriculture, the litmus test of the country’s economy remains the performance of clouds passing through between June and September. So far, the signs aren’t good.
India faces the weakest start to the monsoon in five years, with rainfall 38% below a 50-year average since June 1. While this may change as the clouds move north, the delay alone means crop areas might end up being smaller and yields could fall. Japanese brokerage firm Nomura, projecting from the current forecast, estimates year-on-year agricultural growth in the financial year 2014-15 to fall to just 0.8%, down from 4.8% last year.
That would, almost automatically, mean higher food prices. Rates of onions have already shot up, while other vegetables are also getting dearer. Unless the rains improve, things are unlikely to get any better.
The government has already taken quite a few steps — offloading rice stocks, minimum export prices for onions, calling on states to crack down on hoarding — but there is only so much it can do if the rains don’t come.
* Oil prices
Iraq is in the midst of a violent civil war, with no clear solution to the problem in sight. India imports more than 500,000 barrels of oil from Iraq every day. Those two sentences put together should be giving sleepless nights to Indian policymakers. In fact, even if India didn’t import so much crude from Iraq, it would still be concerned about events there, since it happens to be the second-largest producer of oil among the OPEC nations and a key indicator of what oil prices ought to be.
HSBC’s estimate suggests that a $10 per barrel increase in the price of crude oil would push up wholesale inflation by a full percentage point over 12 months. Although prices have stabilised somewhat, with Reserve Bank of India Governor Raghuram Rajan insisting that he will be keeping close watch, news that the US might be about to intervene in some form in Iraq yet again does not bode well for the oil market.
Government decisions
* Sugar subsidies
Modi’s small government mantra might remind you of conservative parties everywhere, particularly in the US, but that doesn’t mean it has embraced every tenet of conservatism. Protectionism, for example, still has its place in Modi sarkar.
The government – most likely keeping the upcoming Maharashtra election in mind – has decided to retain the export subsidy of Rs 3,300 per tonne of raw sugar, which the UPA had put in place, and massively increased the import duty on the sweet stuff from 15% to 40%.
The government wants to improve the profitability of sugar mills, which are believed to owe farmers around Rs 11,000 crore, but this is projected to lead to a rise in sugar prices by up to Rs 2 or 3 per kilogram. With sugar and related projects having a weightage of nearly 3% in the wholesale price index, it is likely to have a direct impact on overall inflation.
* Off the rails
It may have been partially rolled back – also with Maharashtra in mind – but any increase in freight and passenger costs on the railways ends up having an effect on inflation. The decision to implement across-the-board increases in fares ended up not directly impacting city commuters after the government decided it wouldn’t apply to journeys of up to 80 km on suburban trains. But the hike of 14.3% in passenger rates and 6.5% in freight fares remains.
“The rise in passenger fares will add around 10 basis points to CPI inflation, while there will be a limited indirect impact on the CPI from the freight hike,” said Nomura, the Japanese brokerage firm. “WPI inflation is likely to see a marginally larger impact as the cost of transporting goods such as coal, cement, oil, steel and food grains will rise.”
* Gas trouble
This is the clearest sign yet that the government, despite promising bold measures and bitter pills for the betterment of the economy, is afraid of the monster of inflation. This week, the oil minister announced that any revision of gas prices from the current $4.2 per mBtu will only happen after three months, defusing both the potentially problematic political fallout of any increase as well as its inflationary effects.
Every dollar increase in gas price adds Rs 1,370 per ton in urea production costs and 35 paise per unit increase in electricity tariffs, in addition to increasing CNG and piped cooking gas costs, according to The Hindu. Expected changes to the rate seem to extend from $6 per mBtu to $8 per mBtu.
Not increasing costs, however, means revenues for the year will be significantly impacted, leaving the overall fiscal picture in a problematic position. For now the government isn’t allowing gas prices to add to overall inflation, but it won't be long before it has to bite this bullet too.
