It is a strange irony that the United Progressive Alliance (UPA) government has been caught on the backfoot over its handling of the economy despite having an economist as prime minister. High prices could well be its Achilles' heel with seven percent plus inflation at the wholesale level translating into 10 to 20 percent at the retail level. Food prices, especially edible oils and pulses as well as those of key industrial inputs like steel, are going through the roof and government managers are scrambling to tackle the situation.

The UPA coalition is clearly trying its best to contain inflation, but rising prices are usually linked to systemic issues and these can take a while to resolve. For instance, demand for edible oils has been exceeding domestic production for many years and the shortfall has been made good by imports. A bad season for edible oilseeds within the country combined with high global edible oil prices can thus spell disaster for consumers. Similarly, pulses production has not been keeping pace with domestic demand for quite some time and price stability is now inextricably linked to prices of imported pulses.

The short-term steps that the government can take - and has already taken - include cutting duties on import of commodities like edible oils to make their prices cheaper in the Indian market. The long-term issues, of course, would be to pay more attention to raising the output of domestic edible oils and pulses, but the efforts in this direction have evidently not yielded much results. The net result has been increasingly higher levels of imports to meet the demand within the country.

The question, of course, that can be asked is why import duties on these food products are so high in the first place. The reason is simple - low duties can make imported edible oils or pulses far cheaper than those indigenously produced and ruin the market for Indian oilseeds and pulses farmers. So import levies normally act as a buffer for Indian agriculture against subsidized commodities being sold in world markets.

Industry has also not been immune from inflationary pressures with prices of key raw materials like steel having gone up steeply. Since this could have a cascading effect on industry, the government has tried to curb exports and make imports easier while also trying to appeal to industry to maintain the price line. Whether this approach will succeed in the short run can only be judged within the next few months.

The price crisis being faced by this country is part of the price it has to pay for globalisation. India is no longer insulated from the world economy. Soaring global food prices have had their impact on the domestic market. Rice, for instance, has become a scarce commodity with many key producers recording poor crops this year while Australia's production has virtually petered out due to climate changes linked to global warming. The result is rice prices are shooting up all over Asia where it is a staple diet in most countries. Food prices are thus high not just in India but all over the world. And in developed countries too. The French, for instance, are complaining that even prices of basic foods like bread and cheese have risen by two and three times.

An interesting development is the blame being placed on bio fuels for the increasingly high world food prices. The reported diversion of crops like sugarcane for bio fuels is said to have reduced the acreage available for food crops. In fact, appeals are being made by world leaders to ensure that such diversion is stopped immediately. But whether this kind of diversion has actually become large enough to affect global food supplies is a little difficult to accept though even the International Fund for Agricultural Development (IFAD) has made this point recently.

At the same time, it is clear that with international crude prices at an all time high, there is considerable pressure to move to alternative sources of energy. And development of bio fuels has therefore been given top priority by many countries. In addition, world crude oil prices at record levels of about 115 dollars per barrel have made their contribution by increasing inflationary pressures.

The price spike this time around appears to be a short-term problem that hopefully can be resolved within the next few months by the aggressive policy measures taken in the past two weeks.

The Reserve Bank of India has also stepped in to increase the cash reserve ratio (CRR) for banks, which is the amount that needs to be kept deposited with the central bank as a measure to cool down the economy. The long-term systemic issues, however, need to be tackled on an urgent basis.

Finance Minister P. Chidambaram has repeatedly been warning of the need to deal with supply side issues especially in the area of food products. Agricultural production has stagnated in recent years and this has ultimately resulted in shortages of major commodities in the retail market. With foreign exchange reserves at comfortable levels, the exchequer can easily bear the cost of importing these products. But world food prices have shot up and Indian consumers will have to pay more for staples like wheat, rice, edible oils and pulses. In the long run, therefore, there is no escape from carrying out reforms in the agricultural sector to ensure a rise in productivity levels.

In the short term, however, the government has its work cut out for itself to manage inflation. What is worrying for the political managers is the general election on the horizon as well as polls in states like Karnataka in May. Unless prices are brought under control, the fate of the Congress and its allies in these elections will hang in the balance. Issues like the India-US nuclear deal really do not carry much weight with voters. But prices can become the barometer by which the government's performance is judged during elections.

So watch where prices are going over the next year and you may have some idea of where the UPA is going by the time the general election comes round in 2009.

(Sushma Ramachandran is an economic and corporate analyst. She can be reached at sushma.ramachandran@gmail.com)

April 20, 2008

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