In its monetary policy statement on 8 October 2021, the Reserve Bank of India unanimously decided to keep the policy repo rate unchanged at the historic low at which it has been held since May 2020—4%. All members of the Monetary Policy Committee (except one) also agreed to keep the monetary policy stance accommodative “as long as necessary” so as to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward. Clearly, the short-run growth-inflation trade-off is playing itself out, as one witnesses the economy trying to move along the growth path, even while the inflation trajectory refuses to inspire confidence. The RBI’s policy stance is based on its reading of the inflationary situation as one that is driven by supply-side factors, with the demand remaining weak.
Two questions arise: How robust is the RBI’s reading of the inflation situation in the economy? How can the government and the RBI help in minimising the growth-inflation trade-off while it gives priority to growth?
RBI and its reading of the inflation: As set out in the RBI’s October Monetary Policy Report, the inflation as measured by the headline CPI-Combined was greater than that projected in April 2021 for both Q1 and Q2 of 2021-22 by 35 and 27 basis points respectively. The RBI terms such deviations as unanticipated and attributes these partly to the second wave of Covid at the beginning of 2021-22 and the resultant lockdowns across the country. There was also an unanticipated surge in global energy prices, pushing up petrol and diesel inflation, besides an extraordinary surge in international edible oil prices. Prices of manufacturing sector products too remained high on account of higher input and transport costs.
Clearly, the RBI has been caught on the wrong foot in terms of its assessment of the inflationary situation in the economy, with the reduction in CPI-C witnessed in both August and September a result of a moderation in the price momentum, but more importantly a positive base effect.
Whether the RBI’s current assessment of a weak demand and uneven recovery, which needs to be bolstered through policy support, even if it means keeping inflation in the upper limit of the tolerance band, is correct or not remains a moot question. There is no guarantee of supply-side disruptions ending soon. Inflation rates, especially in the advanced economies, are on the rise, creating a spectre of volatile capital flows. Crude oil may harden even further, given recent reports of OPEC increasing its supplies only slowly, even while the festive season and the ebbing of the Covid infections lead to greater consumer confidence and spending.
Managing the growth-inflation trade-off: The RBI has been concentrating on the growth objective for some time now, even prior to the pandemic. Both the RBI and the government will need to acknowledge the trade-off between growth and inflation, and ensure that attention to growth does not hamper the return of the inflation trajectory to manageable levels. This would require identifying the villains in our inflation story and directly addressing the same. The villains, at this stage, include items such as petrol and diesel (fuel inflation), edible oils and proteins, besides health inflation.
One, the government should recognise the crucial role that fuel inflation plays in both WPI and CPI inflation and its linkages to the rest of the economy, and take steps to reduce such inflation, even though it might have fiscal considerations. Petrol and diesel inflation witnessed highs of 61.53% and 50.69% in the WPI in August 2021, which would have high pass-through effects in the rest of the economy. Even in CPI, the fuel and light component had exhibited a high 13.6% inflation in September 2021. The government should immediately cut taxes on petrol and diesel so that the effect of fuel inflation on transport and logistics costs and thereby on food and manufacturing prices could be mitigated. The government would also need to encourage non-conventional energy production to prevent the power shortage-led inflation, which looms large today.
Two, edible oil prices have demonstrated high inflation levels of 34.19% (September 2021). Much of this has been on account of high international edible oil prices and our dependence on such imports for anywhere from 60–75% of our domestic consumption based on monsoons and domestic production. The government will need to work at improving the domestic production of edible oils, which could take the form of possible subsidies on oilseeds.
Three, with improvements in the dietary habits of Indians, protein inflation—inflation in items such as eggs, meat and fish, milk and milk products, and pulses—has been contributing to India’s inflation trajectory for some years now. The government needs to take steps to incentivise the production of these food items, thereby ensuring that people are not penalised for better nutrition habits.Better anticipation and management of inflation may still give the RBI and government enough space to concentrate on growth while keeping price rise in check.
(Views are personal)
Tulsi Jayakumar, Professor, Economics and Chairperson, Family Managed Business at Bhavan’s SPJIMR (tulsi.jayakumar@spjimr.org)