How to tame inflation | The Financial Express

How to tame inflation

Need a perfect orchestra of many policy tools; on the agri-front, revise weights of food & beverages in CPI

How to tame inflation
From how India was not misled into giving excessive stimulus to boost consumption demand, and instead chose to spend more on infrastructure building that had high multiplier effect on GDP and also created demand.

With Consumer Price Index (CPI) inflation back at 7% in August, and Wholesale Price Index (WPI) inflation at 12.4%, one thing is clear: India is still not out of woods on inflation management. And if September inflation also remains higher than the Reserve Bank of India’s upper tolerance limit of 6%, the central bank, or more specifically, its Monetary Policy Committee (MPC), will have to explain why inflation shot past 6% for three consecutive quarters, as per the 2016 inflation targeting policy. And it may not be a comfortable position for RBI and its MPC members, given their credibility is at stake.

However, these are not normal times. First, Covid hit the world, and, then, the Russia-Ukraine conflict. And now, even climate change (heat waves) is impacting global commodity prices. In this interconnected world, it would be only rational to look at India’s performance in relation to many other major countries. When one compares India with, say, the US and most European countries, where inflation is a tad higher (at 8-12%) and GDP growth likely to be much lower, one can say India has done fairly well. And certainly, India is placed in much better than many other countries like Turkey where inflation in July was raging at 80%, or countries in the neighbourhood like Pakistan (27%) and Sri Lanka (64%). On an average, even compared to India’s own inflation rates in the past, say, during 2004-05 to 2013-14, when average inflation was 7.9%, India’s situation during 2014-15 till now is much better, with average inflation likely to be 5.1%.

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Although RBI and its MPC have been tasked with keeping inflation at 4 +/- 2%, from a macro-economic perspective, it can’t be the sole objective. It must be managed keeping in mind its likely impact on GDP growth. And that’s where the balancing act has to be, and that’s where many other actors have to pitch in to tame inflation. No one could have explained it better than how Union finance minister Nirmala Sitharaman did in a recent conference organised by Icrier on ‘Taming Inflation’. She said very categorically that inflation management requires an orchestrated play of many policy tools. The monetary policy, though very important, cannot tackle inflation alone. It is because, in the Indian context, food and beverages account for a 45.86% weight in the CPI basket. Therefore, monetary policy has to work in tandem with fiscal policy, trade and tariff policy, food and agricultural policy, and even infrastructure policy, which has a multiplier of 2.45. She also mentioned that even the diplomatic deal with Russia for importing crude oil at discounted prices was part of this inflation management strategy. While most economists would agree that inflation management is a complex problem, and it requires various policy instruments to be applied, the question remains who is conducting this orchestra of policies to create a symphony and not a cacophony? Who is the Zubin Mehta of the inflation management orchestra?

Shankar Acharya, who has served as the chief economic advisor (CEA) in the finance ministry with three governments, rightly pointed out that our fiscal policy needs tightening as fiscal deficit (the Centre and states combined) has crossed 10% of the GDP for three years in a row. This is too high and causing inflationary pressures besides loose monetary policy. Krishamurthy Subramanian, who was India’s CEA when Covid hit the world, said that the world has to learn a lot from India’s inflation management while protecting its GDP growth. From how India was not misled into giving excessive stimulus to boost consumption demand, and instead chose to spend more on infrastructure building that had high multiplier effect on GDP and also created demand. For developing economies, may be this was the right strategy.

But as we move forward, how fast can India rein-in inflation and bring it down to, say, 4%, and yet keep GDP growth at around 7%? That would be an ideal situation, which India has not been able to achieve on a sustainable basis over the last two decades. First, public policy has to be re-oriented away from ‘freebies’ towards investments in rural areas with a focus on creating more and higher productivity jobs, better rural infrastructure, improved competitiveness of agriculture and agro-industry, and the MSME sector. Next, higher allocations to agri-R&D for developing climate-smart agriculture will help improve supply response on food. A stable and higher productivity in agriculture even in the face of harsh climate realities will be critical to tame food inflation, which remains the dominant component of CPI inflation. This would require taking a call on rationalising food and fertiliser subsidies, which are burgeoning and are likely to cross `5 trillion in FY23. It will require an innovative policy mix, and one is not sure whether the government will be able to devise it in time. One also needs to urgently revise the weights of food and beverages in CPI basket, which are currently based on the 2011-12 consumption expenditure survey.

All said, it seems that inflation will remain defiant in India at least for this year, and may hover around 7%, despite RBI’s tightening of monetary policy. The GDP growth, on the other hand, is likely to come down a bit lower than RBI’s earlier forecast of 7.2%. If India manages 7% growth in GDP along with 7% inflation in FY23, it would still do fairly well, though it may not still be the most desired outcome.

The author is Distinguished professor, Icrier

Views are personal

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