Inflation & India's Challenges

In its latest annual report, the Bank for International Settlements (BIS), observing that by April 2022 “three-quarters of economies were experiencing inflation above 5 percent”, warned the Central Banks that “inflation was back…as a threatening foe”. Though many have dismissed the rising inflation as a transitory phenomenon, it simply spread widely across countries raising the alarm of stagflation—a prolonged episode of weak growth along with persistently high inflation. 

Amidst this world-over concern about rising inflation, India’s headline inflation hit an eight-year high of 7.79 percent in April as against a year earlier, which however moderated to 7.04% by May. Nevertheless, it remained above the RBI’s targeted upper band of 6 percent. Reflecting on the recent surge in inflation, the Governor of RBI is reported to have said to the effect that there are “global factors in inflation.” What he perhaps meant was that Ukraine war-driven rising prices of food grains, fertilizers, and crude oil, and the strengthening US dollar are directly exerting inflationary pressure on the Indian economy. 

There is, however, a section of economists, who are vehemently arguing against the hypothesis of imported inflation, stating that it is the rising domestic food prices that are pushing Indian inflation further high. And they don’t appear to be way off the mark! For, according to the Ministry of Statistics and Programme implementation, prices of vegetables have posted a soaring year-on-year percentage change of 18.3% on May 22 followed by oils and fats:13.3%; spices:9.9%, meat and fish:8.2%; prepared meals, snacks, sweets, etc.: 7.1%; milk and milk products:5.3% and non-alcoholic beverages: 4.9%. 

They also point out that food prices are rising faster than that of other goods—their relative price is rising. Further, in support of their argument, they are also citing the fact that inflation in India was trending upwards from October 2021, i.e., well before the war in Ukraine started. Hence, they opine that in a scenario of fast-rising food prices vis-à-vis other commodities the rise in repo rate may not be an effective tool to control inflation. For, rising of interest rate being a macroeconomic instrument, can at best control economy-wide excess demand but not any particular price. 

Indeed, this kind of concern about the inadequacy of monetary policy to address the challenge posed by the food-price-driven inflation was voiced even by Joseph Stiglitz, Nobel laureate in economics. He said at Davos that “raising interest rates is not going to solve the problem of inflation. It is not going to create more food. What you do is that you have supply-side interventions. Killing the economy through raising interest rates is not going to solve the inflation in any time frame… At least, trying to do everything we can globally to increase the supply is going to do more in dealing with the problem.”

Even the Fed Chairman, Jerome Powell in his presentation to the US House of Representatives in June, admitted that “a big part of inflation won’t be affected by our tools”, though it is committed to control inflation unreservedly. All this clearly shows that there is very little that the RBI can do to arrest rising energy and food prices.

Over it, in a regime of high inflation, big shifts in relative prices spread across the economy much faster. In such a scenario, expectations become crucial. When people expect prices to go up, they would become more defensive. This in turn may set in motion the danger of a wage-price spiral. Further, as BIS states that any attempt to wish away the price rise as more due to “exogenous” supply shocks will do more harm to an economy than good. For, what is exogenous to one economy often tends to become endogenous to all the economies.

Intriguingly, RBI’s act of rising interest rates has a side-effect too: it adversely impacts growth in the economy. And, persistent high inflation and falling growth are likely to land the country in recession.

No doubt these hard realities, coupled with the unrelenting array of global supply shocks, are making policy calibration a true challenge. For, there are too many dilemmas—compressing external imbalances, preserving macro stability in a hostile global environment by compressing fiscal deficit, addressing the excess demand in the market for foodstuff, etc— to be resolved, that too, without sacrificing growth. A big challenge! Nevertheless, it is necessary to progressively bring inflation down towards its medium-term target in such a way that it hurts growth minimally.

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