Staggered rise in diesel price will squeeze inflation: Swaminathan S A Aiyar

India has stringent price controls on diesel and other petroleum products, yet, wholesale price inflation is 7.3% and consumer price inflation is almost 10%. Under-recoveries of oil marketing companies are a whopping Rs 2,00,000 crore a year. This is six times the Rs 33,000 crore being spent on the government’s flagship employment scheme MNREGA. This wrecks all priorities in spending.

Why do price controls on diesel fail to curb inflation? The Parikh study explains that the implicit diesel subsidy is financed by higher government borrowing, and leads directly to a higher fiscal deficit. Research by Jadhav and others shows that a 1% rise in the fiscal deficit raises broad money (M3) by around 0.9% in Indian conditions. And a rise in M3 is inflationary, since more money chases the same goods and services.

The implicit oil subsidy of Rs 2,00,000 crore is around 2% of GDP today. This causes M3 to rise by around 1.8%, raising the price of all non-oil goods. So, the attempt to keep oil prices down leads to a rise in other prices. It is like squeezing one part of a balloon: this merely creates a bigger bulge in the rest of the balloon. When a high fiscal deficit fuels inflation, it makes exports uncompetitive, increases imports, widens the trade deficit and, so, causes depreciation of the rupee. This further raises the prices of imported goods like oil, worsening inflation in a vicious circle.

PS: Under recoveries of omc’s are different from their losses. under recovery==[ Revenue earned- that revenue which can be earned when the sale is at the international benchmark ] (singapore stock exchange in india’s case).