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When inflation returns

An initial phase of denial and inopportune timing with regard to the EPF interest rate have been the highlights of the past two weeks characterised by a resurgent inflation.

IN THE past two weeks issues connected with the recent spike in inflation have occupied centre stage. The Wholesale Price Index (WPI), which is the widely used measure to track inflation, shot up to 7.51 per cent during the week ended July 24 and further to 7.61 per cent the week after from 6.52 per cent for the week ended July 17. The jump in inflation has been attributed to a combination of factors both domestic and international. The sustained rise in commodity prices led by petroleum prices has been a major cause. (Oil prices touched an all time high on August 6, the day the sharply higher inflation figures were made public). Earlier in July, the Government had announced a price-band mechanism to cushion Indian consumers from oil price volatility. The first increase in the prices of petrol and diesel under the new mechanism was on July 31 which has not been factored in even in the latest WPI.

All these developments have a bearing on price stability. Theories abound as to how soon and in what manner the Government and the Reserve Bank of India will intervene to check inflation. Since the resurgence in inflation this time is hardly a local phenomenon, every one has been looking at happenings in the developed world. The U.S. Federal Reserve having raised the benchmark interest rates twice by 25 basis points each since July (the last revision was very recent) says it will follow a gradual policy of containing price rise. The Bank of England too put up its signalling rates recently.

Curious official stance

In India, however, the initial reaction was one of denial. Even when it was common knowledge that commodity prices, especially oil prices, were not likely to come down soon official spokespersons talked of the worst being over, and cited the resumption of the monsoon as a favourable point. Finally, they attributed the spike to a `base period' effect, meaning that the WPI (on a year-on-year basis) will not be so menacing but for last year 's numbers being on the low side. The Government's reactions have been more considered since then. The Finance Minister and the RBI Governor have said that inflation trends will be closely watched and suitable steps taken.

EPF rate cut

An end to the low interest rate regime has a number of implications. Over the last week, a contentious issue relating to the resurgent inflation came to the fore.

This relates to the timing of the decision of the trustees of the Employees Provident Fund Organisation to lower the administered interest rate from 9.5 to 8.5 per cent. A decision such as always politically sensitive became highly controversial at a time inflation was returning in strength. In fact, the argument that the EPF rate cannot be pegged unsustainably higher than the market rates loses most of its clout. If inflation were to be in the region of 7.5 per cent or so, the real return on a nominal yield of 8.5 per cent (the new EPF rate) is negligible. Chances are that in the days to come it may even become negative. For the EPF trustees it has been a most inopportune time to take a decision like that. There has been strong opposition to it from labour unions and in the nature of things there will not be an agreement. Both sides have valid points in their favour. In the final analysis, justification or opposition to the rate cuts will depend on what perspective one adopts.

One curious argument (in support of the cut) stands out for its specious reasoning. Quoting statistics, it has been claimed that only a small number of EPF subscribers have reasonable balances and it is they and not the vast majority who have small balances who benefit from the higher interest. The fallacy here is two fold: an invidious way of equating a few employee-subscribers with the `rich' is sought to be made. The fact is that even if a subscriber has not been withdrawing (his account) his balance will not be sizable enough to warrant labelling him as rich. Can any employee retire in style on the strength of his PF balances alone? On the other side those who have pitifully small balances actually strengthen the case for greater social security and a higher interest. If despite a higher return on their subscriptions they are unable to save for their retirement (we are talking of the majority of subscribers) then something is seriously wrong with the meaning of social security itself.

C. R. L. Narasimhan

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