How logistics has contributed to inflation

Inflation, inflation, inflation – you switch on the TV or read the newspapers and there is a good chance that you will hear this “bad scary” word.

Mr. Manmohan Singh, our Prime Minister, gave a speech
on how supply chains should become efficient so that inflation can be contained.  I can argue ad-infinitum about how inflation is not about to be controlled easily and has to be corrected by some major structural changes. (economy is overheated, too much money in circulation, low interest rates, food supply issues et al)
But let us stick to logistics and supply chains about which I have some idea, than wander onto macro-economics, which I last studied during my MBA days.
Yes, efficient supply chains can reduce the costs which in turn can be passed onto consumers as lower costs of goods.
Exhorting the industry to use IT and the latest technology to reduce costs is good. But there are lots more that the honourable Prime Minister do to from a government policy standpoint to reduce the logistics costs.
Let us start at the beginning.
At the peril of repeating what many experts say, India’s logistics costs are 13% compared to 9% of the USA. The table below shows the logistics cost as a % of GDP for a few countries.

    Logistics cost as per cent of GDP

China 14.5%
India 14.0%
Singapore 12.5%
United Kingdom 12.2%
France 11.7%
Japan 10.5%
United States 8.7%
Source: IMD (2003). 

GST (General Sales Tax) – Implement GST and abolish CST

For any goods sold across state boundaries the government levies, what is called a Central Sales Tax (CST). The CST has been reduced from 4% to 2% currently.

Without GST, there is a 2% CST on inter-state transfer of goods.
Because of this 2% CST, most companies have a depot in each state to avoid invoicing across state boundaries. This is because goods are 1st transferred to a depot as stock transfer from a Plant or Distribution Centre. Then the goods are invoiced from the depot. This saves 2% in CST.

However, having a depot has a direct cost attached to it – warehouse, people, electricity etc.

Having multiple depots also leads to higher inventory holding as there are now piles of inventory at each depot across the country. Higher inventory has a cost element in terms of blocking working capital. Also, it results in obsolescence and adversely impacts new product launches.

In the event of GST being implemented, companies will have big regional warehouses and distribute from there. This would reduce the cost of multiple-handling and backtracking. Let me illustrate with a few examples;

– Today, most companies have 3 depots in NCR – one for Haryana (usually in Faridabad), one for UP (usually in Ghaziabad) and one for Delhi. With CST these depots can be consolidated to 1 depot.

– Hosur is an industrial hub just 30kms from Bangalore. But it is supplied from Chennai 250kms away, because Hosur happens to be in Tamilnadu.
I am sure there are many more examples. The intent here is to explain the loss of efficiency on account of GST not being implemented.
An added advantage of implementing GST would be that the warehousing industry would get a fillip as companies would migrate to large distribution centres. These large distribution structures would be state of the art warehouses as the scale would support it.
But here is where GST implementation is headed.
Coastal shipping – Modify coastal shipping laws to make it more cost efficient
India has over 7516kms kms of coast,~16 major and ~200 minor ports. Coastal shipping can be a low cost transportation method. This is because fuel consumption by coastal shipping at 4.83 gm/tkm is just 15% of consumption by road and 54% of that by rail.
·         Road 31.3
·         Rail 8.9
·         Coastal shipping 4.8

Coastal shipping is still a protected market and not an open market. Only Indian flag carriers are allowed to take cargo from one Indian port to another Indian port. And since the coastal shipping market is insulated, the policies for coastal shipping are different. These policies, whatever be the logic, right or wrong increase the cost of coastal shipping in India.
The policy issues with coastal shipping, which raise the cost are;
1.      Coastal shipping vessels have the same specification as ocean going vessels. This raises the capital cost of coastal vessels.
2.      Bunkering, spare parts is done at local prices, which are unsubsidised and subject to customs duty.
3.      Coastal shipping crew, the qualifications being the same for coastal and sea-going vessels, have to pay the extant Indian income taxes.

In September 2010, the qualifications for coastal shipping staff, has been reduced. Ocean going seafarers, are treated as NRIs and do not have to pay income taxes. This increases the manning cost of the coastal vessels.
Coastal shipping is used in shipping cars from Mundra to the South. But the scope and potential for coastal shipping is much more.
To be fair, the government has already taken certain initiatives – coastal vessels get a 40% discount on berth charges and THC.
The government also has plans to implement a coastal shipping policy.
Inland waterways – Develop inland waterways
Inland waterways can be developed further. Some progress has been made. But more needs to be done.
Rail and road connectivity from the inland waterways jetties have to be strengthened. Moving cargo by  inland waterways is just one part of the logistics chain; the goods have to reach the end-user and this is possible only by road or rail.
Inland waterways have the advantage of lower fuel consumption (the same advantage as coastal shipping).
Railways – Ask them to get their act together
The Indian Railways play a large and important role in the logistics of India.  In a large country like India, it is more economical to move goods by rail than by road.

Beyond ~700kms and for heavy cargo, rail is the more efficient than road. Yet rail has lost share from 89% in 1950-1951 to 40% in 2000-2001.
Passenger traffic in India is subsidised by the extortionate freight tariff charged by the Indian Railways. Passenger tariffs are not increased as any increase is seen is as unpopular and politically unwise. So the burden comes on freight traffic, which bears the brunt of all the cost increases. This increase the logistics costs. So the passengers, who enjoy the subsidised rail travel, end up paying much more for all the goods they buy! A zero-sum game!

There is a severe capacity crunch on the railways. For an economy which is growing at 8%+, the Indian Railways have to grow at least 10%. The Indian Railways has grown only 6.8% CAGR between 2004-2005 to 2008-2009, while the economy has grown 8.2% in the same period. The Indian Railways has not even kept pace with the GDP growth.

The growth is constrained by track and infrastructure capacity. Railway lines in the golden quadrilateral , golden diagonals and mineral rich belts of East India already run at 100% + capacity utilization. The work on increasing the capacity (3rd line, 4th line) is progressing although at a very slow pace. The DFC Western and Eastern are at least 3-4 years away.

The issue with the Indian Railways is that they have no clear, open and transparent PPP policy. is protected at the cost of the investors and partners.

Without PPP, the Indian Railways finances do not allow creation of capacity at the rate India needs.

Wherever, private investment has come in like private container train operators, the experience of the investors has been negative. This is because the Indian Railways is in the unenviable position of being the Licensor (the Ministry of Railways staffed exclusively by officers from the Indian Railways), Regulator (Railway Board), Competitor (Indian Railways) and a Service Provider (Indian Railways as they provide the locomotive and path)! So obviously, the commercial interests of the Indian Railways

In addition, the Indian Railways focus is on operating trains and construction of tracks is done at a slow pace. Konkan Railway became a reality because there was a separate agency Konkan Railway Corporation which took up the construction. The Pipavav (Pipavav Rail Corporation Limited) Kutch(Kutch Railway Company) rail link became a reality because it was construed as a separate SPV.
Rail connectivity to Ports is another issue. Port capacity has expanded with a commensurate increase in rail capacity to the hinterlands.

Grand finale – !!!!
And finally, one last reason for inflation and where the government the responsibility lies 100% with the government; just click on the link and read ahead. [One hint..the reason is the fashion of the season!]

So dear Prime Minister, while it is good that you have spoken of supply-chains and logistics, it would do well to ask your team to start working on action steps that the government can itself do to improve the efficiency of logistics in India and thereby control inflation.
Ask not what the country can do for you,
Ask what you can do for the country.
                                                            John F Kennedy


2 thoughts on “How logistics has contributed to inflation

  1. Hi Ram,

    I am a complete novice w.r.t the taxation. But, I want to learn about it, especially w.r.t the logistics and supply chain perspective.

    In this article, you mentioned that companies won’t pay the 2% CST if the stock movement is a “stock transfer” and not a “sale”. So, companies use this route to avoid the 2% CST on their goods by setting up warehouse or depot, and show the goods movement as “stock transfer” where it actually might be for a “sale”.

    Is my understanding correct?

    Also, could you let me know how is “stock transfer” different from “sale” exactly? Is it that “stock transfer” means transfer to depot?

    Sai Krishna

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