Monday, Aug 15, 2022

Can Excise Duty Cut On Petrol And Diesel Save India From Stagflation?

Finance Minister Nirmala Sitharaman announced a host of measures that are expected to provide a safety net to India’s poor, reeling under the pressure of continuously rising prices

PTI Photo

For the whole of last year, the Central government and the Reserve Bank of India (RBI) held that inflation was transitory. But with the Russia-Ukraine war showing no sign of waning, the Centre has finally bitten the bullet on inflation.  

On Saturday, Finance Minister Nirmala Sitharaman announced a host of measures that are expected to provide a safety net to India’s poor, reeling under the pressure of continuously rising prices. 

Primary among them was a cut in central excise on petrol and diesel. The Centre announced the excise duty on petrol will be slashed by Rs 8 per litre, while the excise duty on diesel would be reduced by Rs 6 per litre. With this, petrol will be cheaper by Rs 9.5, whereas diesel will be cheaper by Rs 7. 

The government’s announcement comes days after India’s retail inflation for April reached an eight-year high at 7.79 per cent. Food prices have been on fire as the longer-than-anticipated Russia-Ukraine war disrupted global supply chains. 

To tackle rising inflation, the RBI announced an out-of-turn rate hike earlier in May.  

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

Concerns about stagflation are not lost on the major global economies. 

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

Several experts in India are worried that the RBI’s call to move towards a high-interest rate regime would impact growth. Soon after the inflation numbers for April came in, India's Finance Secretary, TV Somanathan, stated the "economic growth rate is likely to slow if the central bank hikes interest rates," anticipating tough days ahead for the economy. His worry is akin to what governments across the world are concerned about.

China, the second-largest economy in the world, is troubled, too. Observers point out that a year-on-year contraction of 11.1 per cent in its April retail sales, coupled with a 2.9 per cent contraction in industrial output, were clear indicators that the dragon economy was experiencing the textbook case of stagflation.  

Worrying Times Ahead

Earlier this month, the US Federal Reserve announced its biggest interest rate hike in over two decades to control rising prices. It lifted the interest rate by half a percentage point, to a range of 0.75 per cent to 1 per cent. Inflation in the US is at a 40-year high, and steeper hikes are expected going forward.  

Germany's April inflation was at a 41-year high of 7.40 per cent, and the United Kingdom's March inflation was at a 30-year high of 7 per cent. Italy's April inflation was at a 31-year high of 6.2 per cent.  

In its April outlook, the International Monetary Fund (IMF) said, "War-induced commodity price increases and broadening price pressures have led to 2022 inflation projections of 5.7 per cent in advanced economies and 8.7 per cent in emerging market and developing economies—1.8 and 2.8 percentage points higher than projected last January." 

Fear Of Stagflation

India's Industrial Production (IIP) growth remained subdued at 1.9 per cent in March compared to an increase of 24.2 per cent a year ago, mainly on account of the low base effect. The IIP growth was 1.5 per cent in January and February amid the third Covid wave. It was just 1 per cent in November and December last year. With RBI expected to hike interest rates in the range of 50-100 basis points in the coming quarters, demand is expected to decline, forcing companies to bring down production further. 

Sabyasachi Kar, RBI Chair Professor at the Institute of Economic Growth, downplays the fear of high-interest rates on growth last week. "There will be a dampening effect on growth. However, as long as it is restricted to rolling back the measures undertaken to deal with the pandemic, the dampening will be mainly due to fiscal consolidation and its effect on growth. This may not be a very large effect." 

Unlike the West, which is not used to dealing with high inflation rates, India has worked out this phenomenon over the last two decades. With 80 crores of its population getting free foodgrain under the Centrally sponsored scheme, a large segment of the Indian population gets insulated from the high food prices.  

Similarly, unlike China, India seems to have seen off the worst of Covid-lockdowns that had a negative impact on India's growth. 

India had recorded an 8.5 per cent growth in the second quarter of the last financial year, but it slowed down to 5.4 per cent in October-December 2021. According to the ministry of statistics and programme implementation, India's FY22 GDP growth is likely to be 8.9 per cent this year.  

"We are not in a situation of stagflation as of now. The growth may come down from whatever was being projected earlier, but it is still likely to be closer to 7 odd per cent. Inflation is high because of multiple reasons. There would be some control on that front but to assume that it would come down to the RBI-mandated 4 per cent quickly, that would be unlikely," explained Devendra Pant, chief economist at India Ratings and Research.

The Red Flag

While things may look not so grim at the moment, India's growth had been tanking even before the pandemic. The RBI's low-interest-rate regime allowed the economy to come close to the Pre-pandemic level of private consumption.  

But fiscal expansion coupled with external factors has heated the Indian economy, stocking fears of destruction of consumption in the country. A recent survey by Local Circles on the issue of inflation pointed out that expensive commodities had impacted the household budget of Indians. The government, till last month, was focussed only on growth, despite high inflation numbers that have been coming in for the past few months. But fears of a political backlash were also playing on the mind of the Centre that has earned a substantial revenue by keeping excise duty high on petroleum products in the past.

India's retail inflation is at an eight-year high. April's retail inflation came in at 7.79 per cent, up from 6.97 per cent seen in March. The price rise was seen across all major commodity groups. Inflation in cereals and products was at 21-months high, vegetables at 17-months high, and spices at 17-months high. Consumer food price inflation jumped to a 17-month high of 8.38 per cent.  

The second-round impact of higher fuel prices has also started reflecting on other goods and services. Inflation for miscellaneous goods and services jumped to a 115-month high of 8.03 per cent. The category is witnessing 23 consecutive months above 6 per cent inflation. Inflation in health services has remained over 6 per cent for the last 16 months. Education inflation touched a 23-month high of 4.12 per cent in April. 

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

While the Centre's move to cut excise duty on petrol will certainly taper inflation in coming quarters, it would be interesting to see how the dent in the government's revenues will impact its ability to invest in the country's economy in the current fiscal.

If growth comes down as a result of reduced capital expenditure by the Centre, its decision to control inflation may not yield the desired results.