The current high rate of inflation is perhaps the most serious issue to have engaged the attention of the central government.
Arvind Virmani, chief economic adviser, Ministry of Finance, tells Siddharth Zarabi and Rituparna Bhuyan that higher oil prices are like a tax paid by the residents of India to nations that export crude oil. Excerpts:
What is your assessment on inflation?
One of the points I have been making for some time is that there is one important difference between this inflation and the past episodes, in that it resembles most closely the oil shock of the 70s.
In fact, in some sense, it is much worse as the current rise was preceded by an increase in commodity prices.
So basically, you had an increase in the global commodity price index of the order of 60 per cent, you had a rise in the food price index of the same amount, you had a sharp rise in iron ore prices, and subsequently you had crude oil, which till this June was up 95 per cent.
Let us start with food. As you know, in June, the global food price index was up 45 per cent, while in June, our primary food prices were up 6.5 per cent.
So, overall, we have managed to insulate ourselves and one of the reasons which we indicated in the Economic Survey is the low level of globalisation of our agriculture sector. In a sense we have kept ourselves from both the benefits and the uncertainty of globalisation as far as agriculture is concerned.
But there is one item - edible oil - whose domestic and world prices are closely related. World prices of edible oil were up by around 60 per cent in June.
And if we look at the wholesale price index segment, which relates to imported edible oils, prices are up 20-25 per cent. So clearly, because we import 60 per cent of our edible oil, that is one area of food where we have been strongly affected by global prices.
The massive construction boom in China in the run-up to the Olympics is likely to taper off. Would this moderate global commodity prices? Also, crude oil prices seem to be falling. Your comments.
To go from the past to the future, the key element as far as the past two-three months are concerned is the price of crude oil. Much of the price shock from the other elements is over, but oil prices reached $144 per barrel before they receded. You are absolutely right, the main concern is not only inflation, but what is called the terms-of-trade shock.
In very simple terms, when oil prices go up, it is like the residents of India paying a tax to crude oil exporters. The higher the price, the larger is the tax one is paying. That extra money is loss of national income, assuming everything else is constant.
Last year, the price of our oil basket was roughly $80 per barrel. For the sake of illustration, consider a 2008-09 price of $120 per barrel. In effect, prices have risen 50 per cent and that means you are paying 50 per cent of your import volume as an implicit tax and that represents the loss to your income, other things being constant.
People earlier said an oil price rise would not affect us. That is true. You had a growing economy, you went from $ 20-$30 a barrel to $80 a barrel without the economy batting an eyelid. But at some point, it does have an effect and we have reached that point.
So is the recent fall in global crude oil prices the beginning of a trend?
I am not taking this as the beginning of a trend yet. But if oil prices stabilise or decline, the whole job of inflation control, macro-economic management and what we have to do about growth will become that much easier.
Is there a comfort level of crude oil prices?
The rise in prices of crude oil has had an effect. Even $120 per barrel has had an effect. You will have to deal with that. Beyond $80 a barrel, it starts having an impact.
Will you be comfortable with $100 per barrel?
When people ask me for an inflation forecast, my problem is that there is too much uncertainty on the oil price front. I cannot make a forecast because no one is willing to tell me what the oil price will be.
It is only now that a few people are coming out and saying that oil prices may fall. I have had two-three global experts here in my office to discuss the matter, and one of them got angry because I kept on repeating my question.
Are more steps needed to moderate consumption of oil products in India?
Absolutely. Users and consumers can only react if the price goes up. We know that for certain products, the price has not gone up. Why would anybody react? If I am still paying the price same as last year, or the year before, I will continue to consume in the same way.
Clearly, the effect of price changes can happen if the price actually changes. Second, there is absolutely no doubt that we should do everything to moderate consumption.
The increase in crude oil prices has not been passed on fully to the retail level. If the government were to further hike prices even moderately, would it not impact inflation?
The BK Chaturvedi Committee, which I was a member of, has looked at everything and given recommendations. What we have tried to do is to make the whole thing more transparent. We will have to wait and see how much of the report is accepted.
In effect, you are saying that India needs to probably prepare and live with further adjustments to fuel prices and the resulting inflationary consequences?
Remember what I said. In some ways, the impact of the rise in price is already there. As a nation, we have lost this income. Whether you absorb it in the fiscal deficit or in the companies and make them non-functional, what can change is only the time pattern. If you raise the price, it looks like it is having a stronger effect on prices than the fiscal deficit.
For example, people have been complaining in South India that the diesel supply is not coming. So you cannot get away from the effects. It is better that we weigh all the options and have a path which gets us to some efficient point. That is what the attempt of the committee has been.
We balance all these considerations and work out some path by which you come to some efficient point so that we stop losing more and more money.