In India, however, historically high single-digit inflation rates had halved in the late 1990s, but hit double digits in 2008, similar to the oil shock of the early 1970s. price preceded the global financial crisis, and after a brief crash coinciding with it, oil prices rose again and remained at a high plateau until 2014. Such shocks increase costs across a wide range sectors, but for sustained inflation, wages also have to rise. The latter is more likely if food prices also rise in a country where food is a large part of its consumption basket, such as India. As high input prices supported food inflation, India was unable to withstand the combination. Wages rose and second-round effects set in.

India was an exception then, as inflation remained low in most countries, especially in advanced economies (EA), despite quantitative easing. Food has a small share in the consumer baskets of AEs.

Although world food prices began to rise in 2002, following oil prices, Indian food inflation remained low, in part because minimum support prices (MSPs) increased only marginally during of this period. Food stocks have fallen to a historic low. But MSPs increased rapidly from 2006-07, as the discipline on purchase prices imposed by low border prices had disappeared. In 2010-11, food stocks and inflation peaked.

There was a willingness to sacrifice production to reduce peaks in inflation. Sharp policy-induced demand contractions reduced output growth for each oil shock, but succeeded in reducing inflation when food price inflation remained low.

Domestic administered fuel prices have neither risen nor fallen as much as internationally, but cumulative fuel inflation in India has far exceeded global levels. This ratchet effect has contributed to Indian inflation. This was one of the cost-push factors creating chronic low inflation.

After minor dips from 2005 as prices became market determined, the sharp drop in 2015 was even less than that of international prices since oil taxes in India were increased. Nonetheless, it has helped achieve the country’s inflation target.

Will history repeat itself? The war in Ukraine has fueled the current oil shock as well as worsening food and other commodity inflation. Will this combination create persistent Indian inflation like in the 2010s? There are risks, but also differences. The war continues, but the growing diversity of Indians means that any challenge creates opportunities as a counter. Higher border prices help the agricultural lobby increase MSPs. The current spike in wheat prices is driving up domestic prices, for example, but it is temporary. Most Indian agricultural prices have reached or are above border prices, limiting the rise in MSPs. Farm lobbies are now asking for protection. The more the trade influences the prices. Exports increased as agricultural productivity, marketing infrastructure and coordination improved.

Other supply-side actions reduce cost push factors. This converts what was once a permanent cost push into a temporary shock; In the United States, covid supply-side bottlenecks are becoming permanent due to excessive fiscal stimulus and tight labor markets. Hence, Indian inflation differs from that of the United States and does not need to follow the latter.

Oil intensity continues to decline: In addition, India is now subject to a flexible inflation targeting regime. Key interest rates need to rise to keep real rates close to equilibrium, if inflation is expected to remain above the tolerance band for any length of time. This assurance of a reaction helps to anchor inflation expectations. But, in the event of a supply shock, disinflation sacrifices production. This is particularly important when national production is below potential and unemployment is high, as in India.

A counter-cyclical movement in excise duties, particularly on fuels, can reduce this sacrifice. If taxes only rise when international oil prices fall, as happened in 2014 and 2020, but do not fall when international oil prices rise, this will reimpose the earlier ratchet, leading to cost drift , keeping Indian inflation higher than international and making it difficult to anchor inflation expectations. Global oil prices were lower at the start of 2021 than they were at the end of 2014. But Indian retail prices were higher. When households and businesses expect oil prices to fall after they rise, they learn to look beyond them and there is less likelihood of second-round effects and rising expectations. ‘inflation.

International oil prices have been excessively volatile after the US Commodity Futures Modernization Act of 2000, which relaxed market trading position limits, among other deregulations, worsening market swings. Brent oil ranged from $132 in mid-2008 to $30 in January 2016, with wide swings between the two. A $18 crash with covid didn’t last long. After Ukraine, it briefly rose above $130 again. The monthly coefficient of variation was 25 before the 2000s and 42 after. Such volatility harms both importing and producing countries and must be taken up in international bodies.

A formula to introduce some countercyclicality in oil taxes for both states and the Center, tied to international price thresholds, would reduce extreme volatility without reverting to the earlier ratchet that drove up costs. This would help establish inflation targeting, reduce delays due to standoffs between the Center and the States and be a step towards including fuel in India’s GST system. Governments would still have the power to change oil taxes at will, but a portion of oil taxes would fall automatically with a rise in world oil prices and rise when those prices fall. The changes would be split between the Center and the States.

Ashima Goyal is Emeritus Professor of Economics at the Indira Gandhi Institute for Development Research

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