The recent inflation estimates from the Consumer Price Index (CPI) as well as the Wholesale Price Index (WPI) confirm that the Indian economy is in an inflationary phase. CPI inflation across India stood at 7.8% this April, with higher inflation in rural areas at 8.4%. While the retail rate of price increase 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 the April rate at 15.1% WPI’s highest in 2011- 12 series. It is also clear that this inflation is not transitory and is likely to remain at higher levels for some time. Itemized analysis suggests volatility in food and fuel may have contributed to the problem, but even core inflation is now close to 6%, suggesting broad-based growth. Is. Policy rates were hiked in an undetermined decision by the RBI’s rate-setting panel last month. This came after the RBI denied the threat for months, even though all figures were pointing to it. It was apparently caught off-guard. Though of late, RBI’s monetary moves will help in easing inflationary pressures.
While the central bank’s loose currency policy contributed to those pressures, the current period of inflation is not entirely a result of it. Fiscal liabilities such as corporate tax exemptions announced before the pandemic contributed to surplus liquidity with the corporate sector. This did not bring any benefit to the economy in the form of increased consumption or investment demand. While the bulk of India’s relief efforts for the pandemic-ravaged economy were through easing liquidity provisions, a tightening of monetary policy is unlikely to do much to contain inflation driven by global factors and supply constraints. A large part of our inflation is essentially a pass-through of international inflationary pressures coupled with rising commodity and petroleum prices. The war in Ukraine has exacerbated the situation, with geopolitical hold-ups playing a role, particularly through their impact on food inflation. Once again, the Indian policy system fell into a shambles.
After the late awakening banned the export of wheat and sugarcane, the export of cotton and other crops is also likely to be banned. A similar flip-flop was seen on petroleum prices, which were frozen till the end of March but were allowed to rise before the reduction in product rates last month. In most cases, the policy response was late, knee-jerk and both disproportionate and irrational.
Now that inflation has settled, the question is what can be done to control it. The standard textbook neo-classical recipe essentially works through monetary tightening, which is what the RBI is doing, with developed countries facing high inflationary pressures. In short, this strategy in common parlance involves slowing growth, often to the extent of causing a recession, if necessary, to reduce expectations of rising inflation. This approach can work in an economy where inflation is the result of economic overheating with excess money chasing too few goods. But this is unlikely to be helpful in our case, where the economy is already sluggish and not characterized by high demand. In fact, we are facing a lack of demand, which is dragging down economic growth. In such a situation, monetary policy has only a limited role in controlling inflation, especially since it is driven by food and fuel, on which rate hikes have a negligible effect.
The figures released on 31st May confirm that our economy is still struggling to return to its pre-pandemic levels. A disappointing 4.1% growth in the last quarter of 2021-22 and 8.7% growth during the year. As the low-base effect further subsides, the challenge is not only to revive growth but also to contain the impact of inflation on people’s incomes. People’s purchasing power is hurt and attempts to reduce demand through fiscal or monetary policy will risk stagflation. Excessive monetary tightening or irrational use of export restrictions is only going to hurt a recovery that is still nascent. This is likely to hurt farmers and small and medium enterprises much more than the organized sector, which is better positioned to deal with contingencies.
Given the twin challenges of inflation and weak growth revival, these are challenging times for our policymakers. But it is also time for policy makers to move away from their current economic paradigm and stabilize the economy with a focus on protecting people’s lives and livelihoods.
The burden of fighting inflation cannot be passed on to the unorganized and rural sectors. The revival of our agricultural economy and the informal sector is critical to a full economic return. It is also important to protect vulnerable households from severe inflation.
Himanshu is Associate Professor at Jawaharlal Nehru University and Visiting Fellow at Center de Sciences Humanes, New Delhi