Lower capex or higher fiscal deficit, a tough choice before centre
Rising inflation and interest rates have knocked a one-two punch on all of us. We were barely lifting our jaws from the floor following the RBI’s unexpected 40 bps policy rate hike last week, and April’s headline inflation at 7.8% further confirms our worst fears of inflation averaging above the RBI’s 6% target band. The only relief, if any, is that India’s inflation at an eight-year high is relatively better than the 40-year and 20-year highs being seen in the US and Europe.
Worryingly though, the price surge is broad-based. Food inflation may spike due to rising production costs and international crop prices, and extreme weather disruptions, while fuel and electricity prices, which remained largely unchanged in the past six months, will likely see a delayed pass-through this fiscal. Core inflation too may hit the roof as producers pass on high cost pressures to customers, even as services inflation catches up with goods inflation. Lastly, global and domestic inflation has initiated a near bloodspill on the rupee, further troubling policymakers. All expect the RBI to hike rates by at least 75 bps, taking the terminal repo rate above 5%, making real rates neutral, if not positive. But even these moves won’t calm down persistent inflation, and experts caution the RBI to resist aggressive and deep rate hikes.
Even globally, the triple whammy of commodity-price shocks, supply-chain shocks and inflation are the biggest headwinds to economic recovery. And the path ahead doesn’t seem rosy given the prevailing supply bottlenecks, elevated commodity prices and aggregate demand, which refuse to get better. Central banks are almost out of ammunition, hence fiscal policy must pull its weight with additional spending in lieu of anticipated food and fertiliser subsidies. But the need for such higher revenue expenditure takes out the fiscal space created by higher tax collections and challenges the government’s strategy to spur growth with productive capex. It’s a difficult choice between lower capex and higher fiscal deficit. Both have consequences, and it’s down to the government to set the plane down softly in a storm.