Can cutting excise duties on petrol and diesel save India from stagflation?

Throughout the past year, the central government and the Reserve Bank of India (RBI) maintained that inflation was transitory. But with the Russian-Ukrainian war showing no signs of waning, the Center finally bit the inflation bullet.

On Saturday, Finance Minister Nirmala Sitharaman announced a series of measures that should provide a safety net for India’s poor, under pressure from continued rising prices.

Chief among them was a reduction in the central excise duty on petrol and diesel. The Center announced that excise duty on petrol would be reduced by Rs 8 per litre, while excise duty on diesel would be reduced by Rs 6 per litre. With this, petrol will be cheaper by Rs 9.5, while diesel will be cheaper by Rs 7.

The government’s announcement comes days after retail inflation in India in April hit an eight-year high of 7.79%. Food prices soared as the longer-than-expected Russian-Ukrainian war disrupted global supply chains.

To combat rising inflation, the RBI announced a contrarian rate hike in early May.

Rising inflation, high unemployment and depreciating currencies have created a vicious cycle that could very well dismantle the fragile recovery that economies have been witnessing in a post-COVID world.

Concerns about stagflation are not lost on the world’s major economies.

Stagflation is a state of the economy defined by high inflation, low growth and high unemployment. And India seems to be on the cusp of this incident.

Several experts in India fear that the RBI’s call to switch to a high interest rate regime will impact growth. Shortly after April’s inflation figures were released, India’s finance secretary, TV Somanathan, said “the rate of economic growth is likely to slow down if the central bank raises interest rates,” anticipating days difficult for the economy. His concern is similar to what preoccupies governments around the world.

China, the world’s second largest economy, is also struggling. Observers point to an 11.1% year-on-year contraction in its retail sales in April, coupled with a 2.9% contraction in industrial production, were clear indicators that the dragon economy was experiencing the case. school of stagflation.

Worrying Times Ahead

Earlier this month, the US Federal Reserve announced its biggest interest rate hike in more than two decades to control rising prices. He raised the interest rate by half a percentage point, to a range of 0.75% to 1%. Inflation in the United States is at its highest level in 40 years and steeper increases are expected in the future.

April inflation in Germany was 7.40%, its highest in 41 years, and March inflation in the UK was 7%, its highest in 30 years. Italian inflation in April was at 6.2%, its highest level in 31 years.

In its April outlook, the International Monetary Fund (IMF) said: “War-induced commodity price hikes and widening price pressures have led to inflation projections of 5. 7% for 2022 in advanced economies and 8.7% in emerging and developing economies — 1.8 and 2.8 percentage points higher than forecast last January.”

fear of stagflation

India’s industrial production (IPI) growth remained subdued at 1.9% in March, compared to an increase of 24.2% a year ago, mainly due to the weak base effect. PII growth was 1.5% in January and February amid the third wave of Covid. It was only 1% in November and December of last year. With the RBI expected to raise interest rates by around 50 to 100 basis points over the next few quarters, demand is expected to fall, forcing companies to cut production further.

Sabyasachi Kar, RBI chair professor at the Economic Growth Institute, played down fear of high interest rates on growth last week. “There will be a dampening effect on growth. However, as long as it is limited to reversing the measures taken to deal with the pandemic, the slowdown will be mainly due to fiscal consolidation and its effect on growth. It may not be a very big effect.”

Unlike the West, which is not used to dealing with high rates of inflation, India has brought this phenomenon under control over the past two decades. With 80 crores of its population getting free food grains under the central government sponsored scheme, much of India’s population is sheltered from high food prices.

Likewise, unlike China, India appears to have experienced the worst of the Covid lockdowns which negatively impacted India’s growth.

India had recorded a growth of 8.5% in the second quarter of the last financial year, but it slowed down to 5.4% in October-December 2021. According to the Ministry of Statistics and Program Implementation, the India’s GDP growth for FY22 is expected to be 8.9% this year.

“We are not in a situation of stagflation at the moment. Growth may be lower than anything previously expected, but it is still likely to be closer to the odd 7 percent. Inflation is high for multiple reasons. There would be some control on that front, but to assume it would quickly revert to the RBI-mandated 4% would be unlikely,” said Devendra Pant, chief economist at India Ratings and Research.

The red flag

Although things don’t look so bleak at the moment, India’s growth had already slowed before the pandemic. The RBI’s low interest rate regime has allowed the economy to approach the pre-pandemic level of private consumption.

But the fiscal expansion coupled with external factors has heated India’s economy, fueling fears of consumer destruction in the country. A recent survey by Local Circles on the issue of inflation highlighted that expensive commodities have had an impact on the household budget of Indians. The government, until last month, was only focused on growth, despite the high inflation rates that have been recorded in recent months. But fears of a political backlash also occupied the minds of the Center which has earned substantial revenue by maintaining high excise duties on petroleum products in the past.

Retail inflation in India is at its highest level in eight years. Retail sales inflation in April was 7.79%, down from 6.97% in March. The rise in prices was observed in all major commodity groups. Inflation for cereals and products reached its highest level in 21 months, that of vegetables in 17 months and that of spices in 17 months. Consumer food price inflation jumped to 8.38%, its highest level in 17 months.

The secondary impact of rising fuel prices has also started to trickle down to other goods and services. Inflation for miscellaneous goods and services jumped to 8.03%, its highest level in 115 months. The category has experienced 23 consecutive months above 6% inflation. Inflation in health services has remained above 6% for the past 16 months. Education inflation hit a 23-month high of 4.12% in April.

To control food inflation, the government banned the export of wheat from the country. Indonesia’s decision to lift the ban on palm oil exports is also likely to help the government control commodity prices.

While the Centre’s decision to reduce excise duties on gasoline will certainly reduce inflation over the next few quarters, it would be interesting to see how the fall in government revenue will affect its ability to invest in the economy. country in the current fiscal year.

If growth slows due to the Centre’s reduction in capital spending, its decision to control inflation may not yield the desired results.

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