Diesel vs inflation PDF Print E-mail
Tuesday, 18 December 2012 00:00
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Finmin says a cut in diesel subsidy will lower inflation

Apart from the headlines of the finance ministry’s mid-year economic analysis (MYEA) lowering its GDP target for FY13 from the budget’s amazing 7.6% estimate to a more sober 5.7-5.9%, there are several interesting points for a larger discussion. On the eve of RBI’s credit policy meeting, apart from talking of the slowing core inflation numbers, the MYEA points to the role of interest rates in cutting corporate profitability—for the manufacturing sector (non-government), it says, interest costs rose from 15.2% of operating profits in Q4FY10 to a whopping 30.3% in Q1FY13. Lower rates further, the unstated argument is, corporate profits will soar, prompting more FII flows, a stronger rupee and hence even more moderation in inflation. The report, though, does caution that not too much should be made of interest rate hikes since the slowing capital formation preceded the hike in policy rates.


The report doesn’t dwell enough on the impact of the government holding excess foodgrain stocks—stocks are 3.13 times what the buffer norms are—though the costs of this are huge. While around 7-10 million tonnes of wheat are stored in the open and likely to rot soon, just exporting this would fetch the government around R20,000 crore at today’s prices. The MYEA does say that the hike in MSPs, though necessary to give farmers remunerative prices, has been a contributor to rising inflation in the country; the mismatch between demand and supply, due to excessive FCI procurement driving out supplies from the market, the report says, has also contributed to inflation. Most interesting is the argument made in favour of raising diesel prices—while the standard argument is that this will raise inflation levels through higher transportation costs, MYEA argues it will lower inflation levels through the fiscal deficit impact. Between 2011 and 2015, MYEA projects average inflation at 7.13% and says a 30% hike in diesel prices will lower this to 5.68%. Whether this signals a cut in diesel subsidies, however, is unclear. The MYEA believes the economy is bottoming out but that seems optimistic. For one, part of the Q2 hike is at odds with the IIP data and the capital formation recovery doesn’t square with the order books of capital goods producers. The Q2 agriculture growth, similarly, doesn’t take into account the drought which will figure in Q3 data. In all probability the economy will pick up only in Q4, necessitating another growth downgrade from the ministry later in the year.


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