Why inflation will be UPA-II's only lasting contribution

UPA-1 will be remembered for two things: the nuke deal, and social sector spending - including the farm loan waiver and the National Rural Employment Guarantee Act (NREGA).

UPA-2 will be remembered for scams, and possibly the Food Security Bill - the NREGA equivalent which is seen as a vote-winner.

But, as always, what looks like an achievement seldom remains one when seen from a long-term perspective.

The nuke deal has not brought India any closer to energy security. It has only brought us more protests and public angst: at Kudankulam and Jaitapur.

NREGA brought higher incomes to the countryside, and helped push up wage costs for the agriculture sector , making farming in some parts unviable. Many farmers took a crop holiday this year for this reason.

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But more than anything else, the UPA tried to compensate for this loss of farm viability by pushing up the minimum support prices of foodgrain by huge margins in 2008-09 - 32 percent for paddy, 40 percent for jowar, 48 percent for moong dal, etc. This is what laid the foundation for lasting food inflation.

Despite the negative growth in food inflation in the week to 24 December (-3.3 percent), the fact is this is merely a statistical and seasonal fall. The roots of food inflation have not been wrenched out. Between higher purchasing power in rural areas and the NREGA wage-push, what we ended up having was protein-based food inflation, and this continues to this day.

[caption id=“attachment_177102” align=“alignleft” width=“380” caption=“The second major reason why inflation is likely to be the lasting contribution of UPA is that the government has simply fought shy of taking the tough decisions on energy pricing it needed to.PTI”]  [/caption]

The second major reason why inflation is likely to be the lasting contribution of UPA is that the government has simply fought shy of taking the tough decisions on energy pricing it needed to.

In the first four years of UPA-1, the government allowed buoyant revenues to bankroll oil subsidies. But towards the end, as oil prices remained stubbornly high and government finances started weakening, we went into an election year and energy prices remained unreformed.

The biggest challenge before UPA-2 is energy pricing - and it has given no indications that it can come to grips with it. None of its allies is willing to carry the can for raising energy prices.

By energy prices we don’t just mean oil. We also mean coal, and power.

The latest change in coal pricing policy, where Coal India plans to charge on the basis of gross calorific value rather than useful heat value, will push up the cost of power by around 60 paise a unit, says BusinessLine. When state electricity boards and distribution companies are already reeling under accumulated losses of over Rs 1,00,000 crore, this additional cost will have to be passed on to customers - which means higher inflation.

If coal, power and oil prices have to be raised, we are essentially asking for higher inflation - assuming this happens through price increases. If, instead, the government opts to subsidise energy - which is impossible, since government is not able to afford even oil subsidies, leave alone coal and power - we will have such a huge budget deficit that the country’s rating will be downgraded and the rupee will fall further. This will raise costs all around.

Clearly, energy - which accounts for over 15 percent of the weight in the wholesale prices index (WPI) - is going to be a key factor in pressuring inflation upwards.

Let’s take a quick view of the factors that will push inflation ahead:

* Food (weight in WPI: 14.33 percent): If the Food Security Bill pressures food prices further due to higher procurement prices and disruption of the private sector trade in foodgrain, we are going to see elevated food inflation for a long time. And this is not accounting for a weak monsoon over the next two years. In any case, protein-based inflation is still to be licked.

* Fuel: (weight of crude, fuel and power in WPI: 15.8 percent): Oil, power and coal prices have to be raised sooner or later. If the rupee stays weak, crude prices will be higher for us even if they fall a bit abroad.

* Manufacturing (eight in WPI: 64.97): Commodity prices are already elevated, and energy costs will rise. But round the corner are the Land Acquisition Bill, the Mining Bill - which again will push up overhead costs for future manufacturing, infrastructure and mining projects. Interests costs will come down, but only slowly.

* Fiscal deficit: From all accounts, the fiscal deficit in 2011-12 will cross 5.6 percent of GDP. This will be inflationary as the government’s additional borrowing requirements will keep interest rates higher than they need to be.

Since spending can only rise as we get closer to 2014, we are going to face a well and truly well-entrenched inflation .

Inflation is, and will remain, UPA-2’s lasting legacy.