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Sunday, April 2, 2023

India’s inflation war complicated by geopolitics & trade protectionism

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High inflation (which is nothing but indirect taxation) by lowering the purchasing power of households, discourages consumption demand.

Of late economic thinking has increasingly been influenced by geopolitics and strategic interests, causing supply chain security concerns to take precedence over supply chain efficiencies. This shift in priorities is a significant contributing factor to high and sticky inflation.

Monetary stimulus to deal with COVID-induced economic contraction is only partly responsible for inflationary woes, more so in the case of India wherein core inflation (which excludes changes in volatile food and fuel prices) has stayed around the 6 percent mark for the 17th month in a row. As since it’s not entirely caused by monetary excesses, it can’t be controlled by monetary tightening alone. Among others, India needs a combination of well-coordinated monetary, fiscal and trade policy measures to bring inflation under control. The sooner the policymakers realise it, the better it will be.

Supply Chain Disruptions

The viral pandemic led countries to opt for supply chain security over supply chain efficiency leading to suboptimal choices such as re-shoring (moving back to in-country production) and friend-shoring (relocating production to friendly countries) to minimise supply chain risks and secure supplies of critical materials. Besides, the actual or perceived unfair trade practices of countries like China along with an increasing focus on geopolitical and strategic goals (sometimes at the expense of consumer welfare) are driving a move towards de-globalisation and trade protectionism. That caps international trade and creates supply chain inefficiencies.

Moreover, the intensifying technology and trade rivalries between the world’s two superpowers, China and the US, further complicate things and so does the blocking of Russian oil and gas prompted by the lingering Russia-Ukraine war. With Russia and Ukraine being major suppliers, the continuing disturbances in the Black Sea region mean lower supplies or slower movement of cargoes, in particular of coal, chemical fertilisers, steel and wheat. As a result, their global prices have risen sharply leading to persistent inflationary pressures.

Similarly, American export restrictions on semiconductor chips will raise the costs for Chinese manufacturers of electronic gadgets thereby forcing Indian importers of these items to pay more for them. That indirectly aids inflation even if the US export control measures are not targeted against India. To retaliate against the US, China is trying to make its solar wafers expensive for all, including India which heavily relies on the import of Chinese wafers. All these developments will raise the cost of production and in turn prices of goods and services.

Impact Of Higher Taxes

Moreover, India’s own internal policy mis-steps often forced by fiscal compulsions, for instance, taxing exorbitantly the whole transportation ecosystem, be it fuels, vehicles or motor insurance has been increasing the cost of moving goods and transmitting cost-push inflation in every part of the Indian economy.

If that was not enough, high import barriers in general, and excessive raw material protectionism raise the operating costs of downstream industries leading to a sustained rise in prices. In the last couple of years, as many as 3,600 tariff lines have seen hikes in import duties. As a result, India’s trade-weighted import duty has increased from 6.3 percent in 2014 to 10.4 percent in 2021. One of the reasons behind this increase in import tariffs on a range of products including electronics, automotive parts, and steel is India’s desire to protect its domestic industries and promote local manufacturing. However, that also means a sharp increase in their prices for downstream industries and end-user consumers. Despite that hikes in import duties have become a common feature of Indian budgets, making inflation control difficult.

To make matters worse, a major challenge for India is high and sticky food inflation which is driven by supply-side factors such as unpredictable weather, low farm productivity and post-harvest losses. These are issues which can’t be tackled in the short run and yet they create complications for policymakers.

Cost-push Inflation

High inflation (which is nothing but indirect taxation) by lowering the purchasing power of households, discourages consumption demand which remains the backbone of the Indian economy. On the other hand, weak consumer demand caps private investment and in turn GDP growth. That calls for containing inflation on a priority basis.

Since the cause of inflation is not entirely increased demand (rather it’s weak if the latest GDP data is any indication), demand control measures alone i.e. tighter monetary policy, will have a limited impact on prices. A little wonder that despite a 250 basis points hike in benchmark interest rates, inflation is still above the RBI’s comfort level. It’s worth mentioning that high interest rates – by raising the cost of capital – aid rather than check cost-push inflation. That monetary tightening in the absence of supportive fiscal and trade policy measures will be of little help.

To sum up, de-globalisation and preference for supply chain security over its efficiency – which often ends up as trade protectionism – may have some benefits for local manufacturers. However, one major downside is its contribution to inflation, which can’t easily be wished away.

What India really needs is a well-coordinated use of fiscal, monetary and trade policies to deal with its inflation challenge. Among others, it calls for lowering import tariffs on key industrial inputs such as steel and textile fibres by junking raw material protectionism. However, lowering import tariffs will come into conflict with the policy of using tariff walls to promote indigenous manufacturing. But that’s really needed if we are really serious about controlling inflation. Besides, both central and state governments also need to walk the talk and substantially cut fuel taxes to reduce shipping and transportation costs, a major factor contributing to cost-push inflation in the country.

Contrary to general perception, inflation is not transitory and hence, it is here to stay unless it’s taken head-on by the government and RBI.

Ritesh Kumar Singh is a business economist and CEO, Indonomics Consulting Private Limited, a policy research and advisory startup. He tweets @RiteshEconomist. Steven Padakandla is a faculty at IMT, Hyderabad. Views are personal, and do not represent the stand of this publication.

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