India’s rupee woes presage period of stagflation

Finance Minister Pranab Mukherjee unveiled a bit more of the government's strategy to rein in the plunging rupee on Sunday. But the wide gap between petrol and diesel prices promises to create problems of its own if political worries force the government to delay hiking prices for diesel and kerosene.

According to CNN/IBN, Mukherjee said that the Reserve Bank of India (RBI) is taking steps to slow the depreciation of the rupee – which has plunged more than 10 percent since the beginning of March. Mukherjee said the central bank had already taken steps to curb speculation in the forex market and increase the inflow of foreign currency. In addition, the RBI recently indicated that it may sell dollars directly to oil companies to ease pressure on the currency, the news channel said.

However, the RBI won't have much wiggle room to cut interest rates, so a period of stagflation may be on the horizon, the Economic Times said.

“Joining the league of doomsayers, Goldman Sachs and Bank of America-Merrill Lynch last Friday steeply scaled down their GDP estimates for the Indian economy to 6.6 and 6.5%, respectively,” the Press Trust of India (PTI) reported.

“These estimates came within days of Morgan Stanley and StanChart revising downwards the country's growth forecasts for the current fiscal to 6.8 and 7.1%, respectively,” the agency said.

All these forecasts are drastically lower than the government forecast of 7.6%.

As GlobalPost reported last week, Prime Minister Manmohan Singh finally took action on Thursday to reassure investors that his government aimed to reduce the fiscal deficit by hiking petrol prices by 7.5 rupees. But the rupee continued to drift downward amid protests from Singh's allies in the United Progressive Alliance (UPA) – which will make a similar hike in diesel and kerosene prices difficult.

Far more costly to the government than the petrol subsidy, artificial constraints on diesel and kerosene will cost India some $35 billion this year. But hiking prices of these fuels has a more direct impact on the poor, because they use kerosene for light and heat in the absence of electricity, and because higher diesel costs result in an increase in inflation.

Meanwhile, Mukherjee said he aims to increase direct tax collections to 12 percent of India's gross domestic product in another move to reduce the budget deficit, the Times of India reported.

"Direct taxes, being most efficient and non-inflationary, are not having their due share in the GDP. The share of direct taxes in the tax basket has been substantial. But my desire is to see, sooner rather than later, them reach 12% of our GDP," the paper quoted Mukherjee as saying.