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On Yahoo: Inflated Bandhs


My latest at Yahoo is on Bandhs and Inflation.

While returning on Sunday from a break in the Himachal mountains, the taxi driver told me he was afraid of the all-India “bandh” on Monday, railing against the fuel price hike and ‘mehengai’ (rising prices). He was afraid of getting attacked by mobs, but at the same time was sympathetic to the cause – prices going out of control, he said.

The small corner of Gurgaon where I live wasn’t affected by the bandh but the residents are quite horrified by rising prices. But that’s the downside of requesting an opinion. You never find people articulating their joy over falling prices, as has been silently happening with computers, mobile phones and telephone bills.

The frustration seems to be over what we are seeing in the agricultural markets – prices of agri-products have risen tremendously over the last year or two and that seems to be affecting the “aam aadmi” – the common man.

Most of those that will read this article will have a very small part of their monthly expense attributed to pulses, grains or milk, so rising prices will hardly pinch their pocket. Using a scientific method (*), I concluded that the affluent people in India don’t give rising prices of rajma a second thought. (**) In fact, the upper-middle classes seem to pay as much or more in rent or home-loan payments than they do for groceries and vegetables; the 10% “standard” increase in rent or property prices every year should have elicited calls for bandhs every year, but food seems a higher inflation fear, even if economically misplaced.

A quick look at wholesale potato prices over the past 10 years reveals that in December 2001 potato prices were about 10% higher than they are today. Although we saw a huge rise in October 2009, prices have moderated again. There has been nearly no price change in potatoes since about 9 years ago, so how come there’s this much inflation? It might just be that wholesale price reductions are not being transferred to the retail buyer. When prices at the “mandi” (wholesale market) go down, the retailer may not easily take prices down because his customer is already used to paying higher rates – and “mehengai” wins arguments.

If you are horrified, note that in India, wholesale markets are happy to even serve retail customers in low volumes. I have visited the mandis of Yeshwanthpur in Bangalore and near Vashi in Navi Mumbai, and prices are indeed lower – you can reduce your monthly grocery bill by 25%. Farmers’ markets are even cheaper for vegetables. One solution to the food “mehengai” is to buy from wholesale markets.

There are many other explanations to why agri-commodities have become costlier over the years – such as migration of labour from farms to cities, the NREGA increasing wages in villages so much that farmers prefer to till less land and constrain supply, farmers demanding their share of the Great India Growth Story, or simply rotting food in government warehouses. Some of these have political motivations – NREGA for instance will not be withdrawn even if it proves to be a major culprit. The other reasons are just payback for our growth and urbanisation, and for land laws that do not allow farmers to sell fragmented land holdings easily – nothing that will be fixed easily, and I expect food prices to continue to increase over the next few years.

Now let’s take fuel prices. They were recently raised because international fuel prices have been going up, making the fixed prices sold by the likes of HPCL and BPCL untenable, and any “under-recovery” funded by the government as a direct subsidy. The subsidies were going up and the government had to raise prices to reduce the subsidy bill, we were told.

But about 45% of petrol prices are taxes, and 29% is just the central government’s stake. Of the Rs. 51 price in Delhi, about Rs. 14 is just the central government’s revenue, of which they use a part to fund the oil companies’ losses. Similarly, around 30% of diesel prices is tax. Karnataka, which has a BJP government and enforced the “bandh” vociferously, takes Rs. 14 per liter of petrol as its share of tax on a petrol price of Rs. 58.

If the central government wanted to keep fuel prices at the same level, they could have reduced the tax and the subsidy at the same time and be done with it. In effect, by raising fuel prices, what the government is telling you is – we refuse to reduce taxes. The subsidy that the oil companies get is inefficient as well – what is to say their losses are not a result of too much slack because the government will cover them anyway? A better solution might be to cut subsidies to zero and rework taxes to a lower level, which is what the government seems to be trying. This way private companies like Shell and Reliance can compete on efficiency and make end user prices lower.

Another way to address fuel inflation is to consider the rupee-dollar equation. If the rupee loses 10% of its value against the dollar – as has happened in the last few months – that really takes the price of petrol up by Rs. 2-3 per liter. The RBI has collected $280 billion in forex reserves over the years, and usually acts very fast by buying dollars when the rupee goes up – it does not do much of the opposite when the rupee falls. If the USD-INR rate were at Rs. 43 today, we might not have needed a fuel price hike at all. And the RBI selling dollars would mean buying rupees, taking money out of circulation and silently addressing inflation as well.

Still, how much does it impact your life? The average internet user might ride about 50 kilometers a day. With a car that gives about 12 kilometers per liter, the fuel cost increase per month is Rs. 500. For a person with a two wheeler, the monthly cost is up by about Rs. 200. To make an elitist argument, the price increase is hardly something the upper-middle class will scream hoarse about.

Indirectly though, fuel prices will hurt everything that is transported on diesel or petrol vehicles. And it will hurt the poor the most. Inflation is a function of supply and demand, and while demand has gone up, supply has not managed to keep pace. The RBI is trying to curb demand through interest rate hikes – even though that is hardly effective anymore, as it seems to be delinked to what rates bank customers get charged. It would be useful to remove impediments to supply – such as freeing the “licensed” intermediaries (the wholesale markets), addressing small farms (requires changes in local laws), more efficient food storage and distribution of perishables, rapidly reducing import duties in shortage situations, water supplies to agricultural land and so on. Even working towards faster distribution of natural gas – where our offshore reserves are high enough to make a difference – will help reduce supply constraints in the long run. Very few of these solutions can be done overnight or in response to a one-day-bandh; yet, if we don’t start now, we won’t see the results in a few years.

We could, in the meantime, attempt to use taxes and exchange rates to keep fuel prices at affordable levels. This can only hold the fort for so long; it is impossible to fight rapid crude-oil price rises like in 2008, when prices rose to $140 a barrel and then fell to $30 a barrel within a few months. Headline inflation will come down in the coming months because of inordinately high prices in late 2009 – a high “base effect”; but expect the rage against inflation to take center stage in our country, while the west watches in envy and fights deflation in theirs.

(*) Which involved asking people on Twitter and email, and cherry-picking the results.
(**) This has serious consequences for air pollution, but I digress.


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