"It's the economy, stupid." That was a catch phrase in the Clinton administration in the U.S. indicating the critical role of the economy in governance. It could well be the motto for the UPA government right now since rising prices have got it well and truly on the backfoot.

Inflation of around 7 per cent at the wholesale price level is translating into ten to 20 per cent increase at the retail level. Food prices especially edible oils and pulses are going through the roof and government managers are scrambling to tackle the situation.

Analysts as well as nervous politicians often recall the time that soaring onion prices and shortages became the precursor to the fall of a government. High prices can become the Achilles'heel of any administration.

The UPA coalition is trying its best to overcome this problem but prices are usually linked to systemic issues and these can take a while to resolve. For instance, demand for edible oils has been exceeding domestic production for many years and the shortfall is made good by imports.

A bad season for edible oilseeds within the country combined with high global edible oil prices can thus spell disaster for consumers. Similarly, pulses production has not been keeping pace for domestic demand and price stability is linked to prices of imported pulses. The short term steps that the government can take - and has taken immediately - include cutting import duties on import of commodities like edible oils to make their prices cheaper in the Indian market.

The question, of course, that can be asked is, why are import duties so high in the first place. The reason is simple - low duties could make imported edible oils or pulses far cheaper than those indigenously produced and ruin the market for Indian oilseeds and pulses farmers. So import duties normally act as a buffer for Indian agriculture against subsidized commodities being sold in world markets.

Globalisation has also played a role in the current crisis. World food prices have peaked and the impact has percolated into the Indian economy. Even rising world crude oil prices have made their contribution indirectly by increasing inflationary pressures.

The price spike this time around appears to be a short term problem which hopefully can be resolved within the next few months by the aggressive policy measures taken in the past week. But the long term systemic issues need to be tackled on an urgent basis. Finance Minister P. Chidambaram has repeatedly been warning of the need to deal with supply side issues especially in the area of food products.

Agricultural production has stagnated in recent years and this has ultimately resulted in shortages of major commodities in the retail market.With foreign exchange reserves at comfortable levels, the exchequer can easily bear the cost of importing these products. But world food prices have shot up and Indian consumers have to pay more for these products. In the long run, therefore, reforms in the agricultural sector have to be carried out to ensure that productivity levels go up.

In the short term, however, the UPA government will have its work cut out for itself. What is worrying for the political managers is that general elections are on the horizon along with polls in some states like Karnataka in May.

Unless prices are brought under control, the fate of the Congress and its allies in these elections will hang in the balance. Issues like the Indo-US nuclear deal really do not carry much weight with voters. But issues like prices are close to everyone's heart and become the barometer by which the government's performance is judged during elections. So watch where prices are going over the next year and you will have a good idea of where the UPA is going by the time general elections come round in 2009.

Courtesy: The Week, April 17, 2008