Centre, not RBI, can help fight inflation | Deccan Herald

Clipped from: https://www.deccanherald.com/opinion/in-perspective/centre-not-rbi-can-help-fight-inflation-1016799.html

A joint decision-making process between the two policymakers, the RBI and the Union Ministry of Finance, is the need of the hour

Representative image. Credit: iStock PhotoRepresentative image. Credit: iStock Photo

The ‘Delta’ variant of coronavirus, which became prominent even as the second wave of the pandemic subsided, has upset all previous growth projections. India’s growth projection has been revised downward from 12 per cent to 9.5 per cent. Another matter of concern is inflation, reflected in increases in the monthly Wholesale Price Index (WPI) and Consumer Price Index (CPI) since January 2021.

The WPI covers manufactured goods, raw materials, food and fuel items. Their transport costs to retailers, using diesel and petrol, are taken into the computation. However, the CPI excludes the prices of food and fuel, on grounds of their volatility. Eventually, the CPI captures inflation in the WPI with a lag of about one month.

India is the world’s third largest importer of petroleum crude, importing 83 per cent of its requirement. World crude prices determine domestic inflation. The Reserve Bank of India (RBI) is entrusted with the goal of ensuring price stability, targeting CPI-based inflation. Its mandated goal is to maintain inflation at or less than 4 per cent, plus a margin of 2 per cent, for a maximum of 6 per cent. 

Due to the worldwide pandemic-induced recession, the price of the benchmark Brent crude crashed to $20/barrel in April 2020. The crude price started to look up following the arrival of Covid-19 vaccines in December 2020. As the worldwide demand for crude revived, its price rose from $48.73/barrel in December 2020 to $53.70 in January 2021 and went up to $66.40 in May. In June and July, it was hovering around $75/barrel. In India, petrol price at the pump crossed the psychologically disturbing mark of Rs 100 per litre in June.

Challenge before RBI

The CPI inflation rose from 4.06 per cent in January to touch 6.31 per cent in May. That is a high level, exceeding the upper band of the RBI’s mandate. In June, it was 6.26 per cent, still above the upper limit of 6 per cent. July data will be available in mid-August.

Read | Tax move may not be enough to repair India’s bad reputation

The RBI’s Monetary Policy Committee faces a challenge as it is to make its policy announcement on August 6. In the context of its stand that economic recovery “still needs to be nurtured”, any increase in the policy rate from 4 per cent to fight inflation would be disruptive to the growth process. Any rise in interest rate will raise the interest rate differential. Speculative inflows from overseas risk-loving investors would result in money supply increasing, pushing up inflation.

So, the question before policymakers is: “Would a fiscal policy action be more appropriate?”

Reduction in fuel taxes?

A joint decision-making process between the two policymakers, the RBI and the Union Ministry of Finance, is the need of the hour. Such coordination is consistent with shared national objectives, growth and price stability, fiscal policy decisions, include taxation policy for facilitating growth, as well as reducing inflationary pressures.

In 2019-20, the tax revenue from the petroleum sector for the Centre and the states was Rs 5.6 lakh crore; and for the states, Rs 2.6 lakh crore from VAT or 18 per cent of the revenue of the Centre and 7 per cent of the states’ revenue. The petrol retail selling price (RSP) on August 4 was Rs 102 per litre. A major component, taxes (central excise and state VAT) amounted to Rs 59, or 57 per cent of the price per litre. The tax rate as a percentage of the net price was 137 per cent. On diesel, central excise and VAT is Rs 45, or 61 per cent of diesel RSP, the tax rate being 101 per cent of the net price. The payable price by petrol bunks for petrol and diesel, including the basic price, freight and dealer commission, was Rs 43 and Rs 45 per litre, respectively.

If central excise on petrol (Rs 32.8/litre) is suspended for one year, the tax burden would only be the state-imposed VAT, Rs 26/litre, and the tax rate would be 60 per cent of the net price of Rs 43. If the Centre also decides on suspension of excise on diesel (Rs 31.8/litre) for one year, the state VAT would be Rs 13.04 per litre. The Centre’s loss would be about Rs 3.46 lakh crore, the estimated revenue for the current fiscal. It will be an addition to the estimated fiscal deficit of the central government of 7.8 per cent and to states fiscal deficit of 4 per cent — in all, a total deficit of 11.8 per cent of GDP.  Increase in deficit by suspension of central excise is worth incurring as gains from the anti-inflationary measure would be considerable. The size of reduction in central excise can be calibrated by authorities to meet the objective: reducing inflation.   

The suspension of central excise on fuel would be a relief to states as their VAT system on fuel would not come under pressure. Consumers would be relieved with petrol and diesel prices falling to Rs 63 and Rs 57 per litre, respectively. Above all, once announced and implemented, the CPI inflation will come down. 

(The writer is an Honorary Adjunct Professor, Amrita School of Business, Bengaluru Campus)

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