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India’s official inflation rate for the month of August is 6.83 percent, down from 7.44 percent the previous month. It is still above the 6 percent maximum rate which is the red line for the Reserve Bank of India. Ever since the monetary policy shifted to inflation targeting in 2016, the permissible band of inflation is between 2 and 6 percent, for the consumer price index (CPI). This is the seventh time in the past twelve months, that the monthly inflation rate is above 6. Would that not be disconcerting to the RBI’s Monetary Policy Committee (MPC)? They need to tighten money supply further to reduce inflation. But they have chosen to keep the interest rate unchanged, hoping that inflation will come down by itself. The RBI Governor too has indicated that inflation will remain high for some time.
Using food to create fuel for cars is a controversial policy especially when the world is experiencing high food inflation
India’s consumer price index consists of a weighted average of around 450 different items in the consumption basket (different for rural and urban consumers). But almost 49 percent of the weight goes to food and related items. Hence if food inflation is high naturally the overall inflation is high. Food inflation which has a weight of nearly 49 percent is currently running at 10 percent, thanks to rising prices of vegetables, oilseeds, pulses, milk and even cereals. India has used a combination of banning exports or putting a hefty export tax on a variety of agricultural products. These include wheat, rice, sugar and onions. This affects the earnings of farmer’s who were eyeing lucrative profits from exports.
Oil imports bill can only be beaten by more than expected exports of software and IT services
For instance, India exported 7.4 million tonnes of parboiled rice in 2022 but now there is a stiff 20 percent export duty in place. India accounts for 40 percent of the world’s rice exports, and thanks to India’s curbs, this has created additional scarcity in the world. The export curbs from India have affected importing countries like China, Philippines, Bangladesh, Indonesia and Nigeria. In Philippines a minister might have to resign due to the steep prices of rice. Has the ban or export tax reduced rice inflation in India? Not really, because apparently the broken rice (on which the export tax applies) is headed for ethanol production.
Using food to create fuel for cars is a controversial policy especially when the world is experiencing high food inflation. The FAO’s all rice price index rose by 9.8 percent in August and is now at a 15-year high. Such inflation is bound to seep into India. The ethanol policy is motivated by trying to save precious dollars which we spend on the import of crude oil. But if domestic food inflation is the price to pay we have to think carefully about using food crops for fuel production.
India is running a high deficit, and its national debt is also rising. All attempts at controlling the deficit seem to be futile...In the past seven years, as per an answer to a Parliamentary question, nearly 15 trillion rupees worth of bad loans have been written off by public sector banks
Going beyond food inflation, the outlook for crude oil is also anticipating high prices. Due to supply cuts by Russia and Saudi Arabia, oil prices have already crossed 85 dollars, and will stay high. Since this affects India’s imports adversely, there is a possibility that the Indian rupee will further decline from 83 to 85. Oil imports bill can only be beaten by more than expected exports of software and IT services. This is easier said than done, since there is a palpable slowdown in the software sector. Of course, the medium to long term outlook for India’s software services remains very strong, as indicated by NASSCOM the industry body.
Apart from food inflation, oil prices and a slipping rupee dollar exchange rate, one major contributor to the inflationary trend is the size of the fiscal deficit. India is running a high deficit, and its national debt is also rising. All attempts at controlling the deficit seem to be futile. Of course, during the pandemic, the deficit had to rise, since the government had to use emergency rescue measures in terms of free food, subsidised loans and ample liquidity. But some decisions can raise eyebrows. For instance, the free food grain scheme now running for more than 48 months, is costing the exchequer cumulatively 4.5 lakh crores.
The large and heavy overhang of India’s perennial fiscal dominance (and burden) cannot be undone merely by tightening the monetary policy. Even that is showing forbearance
The cabinet recently announced the 1.7 trillion revival package for the debt-ridden telecom company Bharat Sanchar Nigam Limited. In the past seven years, as per an answer to a Parliamentary question, nearly 15 trillion rupees worth of bad loans have been written off by public sector banks. This has fiscal implications, since equity capital has to be infused into the banks by the Central government. The write-off could be one contributory factor leading to the lower bad-loan ratio and improving health of the banking sector. But what cannot be denied is that fiscal spending is too stretched and leading to inflationary pressure.
India’s fiscal situation is more dire than is acknowledged. If we compare the debt service ratio, i.e. how much of the government’s revenue goes simply to pay interest on the rising debt mountain, India is way above the median for all countries. Due to the high deficit, the interest rate tends to remain high, leading to a disadvantage for crucial sectors like housing, real estate and indeed all the industrial projects. India tried very hard to curtail deficit spending tendency, by trying to make it illegal to exceed a certain limit.
The free food grain scheme now running for more than 48 months, is costing the exchequer cumulatively 4.5 lakh crores
The Fiscal Responsibility legislation passed by parliament in 2003 made it illegal to exceed 3 percent of the GDP as the fiscal deficit limit. The stark reality is that in not even a single year has India not breached this limit. So much so that the FRBM law has been rendered toothless. A review of the law was conducted just before the pandemic and that too won’t be of much use, since debt and deficit levels are far above what is healthy for the economy.
It is true that in a noisy and competitive democracy there is a clamour for more spending by vocal groups and vested interests. On top of this there is the increasing tendency to offer freebies. Plus, the new industrial policy which offers schemes like Production Linked Incentives and also protection from imports. All of these measures, for good or bad, have fiscal implications, which not only jeopardise sustainability of the debt and fiscal stance, but also add to inflationary pressures. The large and heavy overhang of India’s perennial fiscal dominance (and burden) cannot be undone merely by tightening the monetary policy. Even that is showing forbearance. The inflation fight is indeed a very difficult one in India.
(Dr. Ajit Ranade is a noted economist)