The difficulty of inflation control under our current circumstances
PremiumThe standard neo-classical prescription of monetary tightening could worsen conditions for many
Recent estimates of inflation from the consumer price index (CPI) as well as wholesale price index (WPI) confirm that the Indian economy is in the midst of an inflationary spell. CPI inflation across India this April was 7.8%, with higher inflation in rural areas at 8.4%. While the retail rate of price-rise has breached the Reserve Bank of India’s (RBI) upper limit of 6%, WPI inflation has been in double digits for more than a year, with April’s rate of 15.1% the highest in the WPI’s 2011-12 series. It is also clear that this inflation is not transitory and is likely to stay elevated for some time. A break-up by items shows that volatility in food and fuel may have contributed to the problem, but even core inflation is now close to 6%, which suggests a broad- based increase. In an unscheduled decision of RBI’s rate-setting panel last month, policy rates were hiked. This came after months of RBI denial of the threat, even though all statistics were pointing towards it. It was clearly caught off-guard. Although late, RBI’s monetary moves will likely help in moderating inflationary pressures.
While the central bank’s loose money policy did contribute to those pressures, the current spell of inflation is not entirely a result of it. Fiscal giveaways, such as the corporate tax sops declared before the pandemic, contributed to surplus liquidity with the corporate sector. This did not benefit the economy in the form of increased consumption or investment demand. Though the bulk of India’s relief effort for an economy battered by the pandemic was through provisions of easy liquidity, tightening monetary policy is unlikely to do much to contain inflation driven by global factors and supply bottlenecks. A large part of our inflation is essentially a pass- through of international inflationary pressures with rising commodity and petroleum prices. With the war in Ukraine aggravating the situation, geo-political hold-ups have played a role, particularly through their impact on food inflation. Once again, the Indian policy set-up was caught napping.
A late awakening was followed by export bans on wheat and sugarcane, with cotton and other crop exports likely to be barred too. A similar flip-flop was seen on petroleum prices, which were frozen until March end but were allowed to rise before a reduction in excise rates last month. In most cases, the policy response was late, knee-jerk and both disproportionate and irrational.
Now that inflation has settled in, the question is what can be done to control it. The standard textbook neo-classical prescription essentially works through monetary tightening, which is what RBI is doing, along with developed countries faced with higher inflationary pressure. In essence, this strategy in layman language involves slowing down growth, often to the extent of causing a recession, if need be, to tame rising inflationary expectations. This approach may work in an economy where inflation is a result of economic overheating with excess money chasing too few commodities. But it is unlikely to be of help in our case, where the economy is already sluggish and not characterized by excess demand. In fact, we are suffering a deficiency of demand, which is pulling down economic growth. In a situation like this, monetary policy has only a limited role in controlling inflation, especially since it is driven by food and fuel, over which rate hikes have insignificant influence.
Data released on 31 May confirms that our economy is still struggling to get back to its pre-pandemic level. Growth at 4.1% in the last quarter of 2021-22 and at 8.7% over the year was disappointing. As the low-base effect dissipates further, the challenge is not just to revive growth but also control the impact of inflation on people’s incomes. The purchasing power of people has been hurt and an attempt at reducing demand through fiscal or monetary policy would risk stagflation. Excessive monetary tightening or the irrational use of export bans is only going to hurt a recovery that is still nascent. It is also likely to hurt farmers and small and medium enterprises much more than the organized sector, which is better placed to deal with contingencies.
These are challenging times for our policymakers, given the twin challenges of inflation and a fragile growth revival. But it is also time for policymakers to move away from their existing economic paradigm and stabilize the economy with a focus on protecting the lives and livelihoods of people.
The burden of fighting inflation cannot be passed on to the unorganized and rural sectors. A revival of our agrarian economy and informal sector is crucial for a full economic comeback. It is also important for shielding vulnerable households from raging inflation.
Himanshu is associate professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi