Beyond appeals: Prices are the best way to change consumer behaviour

The crisis at the Strait of Hormuz will have a deep and prolonged effect on energy markets globally — and thus on inflation, output and growth. There is still no clarity on how long the crisis will continue. The Union government is clearly taking this threat seriously, which is admirable. Prime Minister Narendra Modi’s recent speech on the subject shows that it recognises the potential dangers of this geopolitical shock — especially the threat it poses to macroeconomic stability. When the price of crude oil stays elevated for long, India is particularly vulnerable to pressures on its external account. Thus, the Prime Minister was careful to stress the importance of conserving foreign exchange. He centred this around seven appeals to the nation. These include minimising foreign travel, cutting down on the amount of cooking oil used, and using public transport in order to reduce the consumption of petrol and diesel. The Prime Minister further called upon farmers to use less fertiliser, which is dependent on imported inputs that are part of the petrochemical supply chain. There was also an appeal to not buy gold. Indian purchases of gold are a perpetual drain on foreign exchange. 

The government’s intent is to be lauded. Naturally, however, this cannot be the extent of how the government responds to the threat. Behavioural injunctions are valuable but policy choices matter even more. If the government allows prices to adjust swiftly in response to the changed supply situation, then people will automatically follow suit. There is reluctance in the Indian polity to allowing prices to shift, for fear of the impact on vulnerable sections. This is a valid concern. Naturally, any distress that might be caused can and should be remedied by targeted intervention. For instance, the government has already set aside a credit-guarantee plan for this purpose. Such concerns are, however, not a reason to avoid using prices. In particular, it is far more likely that the consumption of petrol and diesel will be reduced if their prices are allowed to rise in a controlled but responsive manner to the global prices. 

This is, technically, the system India already has to some extent. But the fact is that there are still political constraints on how much prices are allowed to adjust. Under such crisis circumstances — and it is clear now that the government correctly views this as a crisis — these constraints should be set aside. Some in Opposition parties have already begun to suggest that any changes to the prices of petrol and diesel will become a political issue. But these efforts must be ignored. There is every reason to believe that the public understands the broader global context of price increases. The government must also clearly communicate that neither the oil-marketing companies (OMCs) nor the Budget can indefinitely shield consumers. OMCs are reported to be facing under-recoveries worth ₹30,000 crore per month. 

Two other macroeconomic realities should be kept in mind. First, the safest approach to concerns about the current-account deficit is to allow the rupee to depreciate in such a way that imports generally decline. This does indeed appear to be the current policy, and it should be maintained. The second is that solid capital inflows can help manage such situations. Thus, the government must identify why the economy continues to be subject to capital outflows, including by foreign institutional investors. Reversing this trend will require accelerating the pace of reforms, including administrative reforms.