Fighting inflation is not only the responsibility of RBI

The notion of monetary policy being the sole or primary instrument for controlling inflation is incorrect on many grounds, both theoretical and empirical. The primary assumption here is that inflation is in most cases a monetary phenomenon, driven by easy liquidity with too much money chasing too few goods. While this may happen in many developed countries, it is not true in the case of India. The one-size-fits-all solution ignores the nature of inflation, which can vary from country to country. While some part of inflation in India is driven by external factors, such as increases in global fuel and commodity prices, as well as exchange rate volatility that contributes to imported inflation, inflation has recently been largely driven by local food prices. Inspired by. Unlike fuel and commodity prices, which are driven by international price movements, food inflation is largely domestic. In fact, globally, food prices for all major food groups have declined from their peak levels. On the other hand, a major part of today’s inflation in India is driven by food. This inflation is almost half of the total inflation since June 2022.

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Within the food group, it is cereals that have seen a rally, with their inflation rate crossing 10%. Much of this is driven by wheat and rice. The inflationary trend for cereals has strengthened, with expected reduction in rice production on account of unseasonal rains and deficient monsoon in major rice producing states following a reduction in wheat production. Another factor that is likely to put upward pressure on food prices is unprecedented inflation in agricultural inputs. While overall wholesale price inflation has been above 10% for more than a year, for a large part of this year, inflation in agricultural inputs has been above 30%. Rising cost of farming will add to food inflation.

While the outlook for food inflation is not very positive, monetary policy and interest rate hikes will not have any impact on that. It also raises the larger question of the role of fiscal policy in controlling inflation. The responsibility for containing inflation rests as much on fiscal policy as on monetary policy. There is now a consensus in the economic literature about the various assumptions that an effective approach to controlling inflation requires an equally important role of fiscal policy. In India too, this is important given the nature of inflation and our development challenge. India’s economy is still recovering from the pre-pandemic slowdown, which is followed by the Covid disruption. In a demand-constrained economy, the role of fiscal policy becomes even more important. The rural economy is already in crisis due to the fall in real wages over the past two years. Inflation in agricultural inputs has further reduced the income of farmers.

This is where fiscal policy can not only help sustain growth but also control inflation. Fiscal measures that lead to an increase in the deficit and government debt can be inflationary in the face of excess liquidity and demand. However, increased expenditure to revive demand is unlikely to be inflationary if it is met by increasing government revenue instead of using the deficit route. On the other hand, progressive taxation can provide not only much needed revenue, but also include additional demand for conspicuous consumption, a role traditionally assigned to monetary policy.

The last decade has seen countries suffering from unnecessary austerity measures amid tax breaks given to the corporate sector to boost growth, which have neither increased nor contained inflation. India followed the same path, offering massive corporate tax exemptions with little showing of private investment growth. It is high time the government looks at fiscal measures financed by progressive taxation to boost growth. This should complement the monetary measures in India’s effort to control inflation and revive growth.

Himanshu is Associate Professor at Jawaharlal Nehru University and Visiting Fellow at Center de Sciences Humanes, New Delhi.

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