How to control inflation

Policy makers must have breathed a sigh of relief upon hearing the news of GDP growth at 8.7% for the year 2021-22. Based on a 6.6% GDP contraction in 2020-21, it was somewhat in line with expectations. The economy now looks largely out of the shadow of Covid-19, and only a notch better than in 2019-20. But the big question remains: can India achieve similar economic growth in 2022-23? And more importantly, can India contain runaway inflation which is at 7.8% (CPI for April 2022), with food CPI at 8.4% and WPI at over 15%?

My humble assessment is that unless bold and innovative steps are taken on at least three fronts, GDP growth and inflation are both expected to be between 6.5 and 7.5 percent in 2022-23. Targeted policy action is needed on three fronts: first, a rapid tightening of accommodative monetary policy; second, prudent fiscal policy; and third, a sound trade policy. Let me elaborate a bit on each of them.

The Reserve Bank of India (RBI) has a mandate to keep inflation at 4% plus or minus 2%. The RBI has already started the process of monetary policy tightening by raising the repo rate, albeit a bit late in the game. RBI Governor says it is ‘reckless’ to predict he will continue down this path, but the speed at which he can drop to pre-Covid levels is an issue that requires better assessment of the likely consequences of his actions on growth and inflation. A fine calibration would therefore be necessary. I expect that by the end of 2022-2023, the pension rate will be at least 5.5%, if not more. It will always remain below the likely inflation rate and therefore depositors will continue to lose the real value of their money in banks with negative real interest rates. This only reflects an inherent bias in the system – in favor of entrepreneurs in the name of growth and against depositors, which ultimately leads to increased inequality in the system.

The second front on which a strong lifting of weight is needed comes from the mandarins of the Ministry of Finance for a more prudent fiscal policy. It slackened in the wake of Covid-19 which saw the Union government’s budget deficit climb to over 9% in 2020-21 and 6.7% in 2021-22, but now needs to be tightened. Can it reduce its budget deficit to less than 5%, let alone the advice of the FRMB law to reduce it to 3% of GDP? I don’t see that happening, especially when improved food and fertilizer subsidies and cuts in petrol and diesel duties will cost the government at least Rs 3 trillion more than expected in the budget. This will surely push the budget deficit above the 6.4% target unless tax revenues improve significantly or the government does all it can to monetize land and state-owned enterprise assets. My assessment is that fiscal policy will remain loose, more populist and confusing, and the fiscal deficit will remain in the 6.5-7.5% range in 2022-23. I don’t see it going below 5% even by the end of 2023-24.

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The third front is that of a rational trade policy. In a knee-jerk reaction, India announced a ban on wheat exports and imposed restrictions on sugar exports. Calls are also being made to ban cotton exports. Export restrictions/bans go beyond agricultural products, even iron ore and steel etc. in the name of controlling inflation. But blunt export bans are bad trade policy and only reflect the panicked face of the government. A more mature approach to filtering exports would be through a gradual process of minimum export prices and transparent export duties for short periods, rather than blunt bans, if they are desperately needed to promote consumers. However, even with these restrictions/bans on exports, I doubt that the government can control the inflation which is a global phenomenon today. Can India completely isolate itself from the global economy? Can he stop exporting all the products whose prices are rising – from mangoes and corn to fish and spices? A prudent solution to moderate inflation in the country lies in a liberal import policy, reducing tariffs at all levels. Just to cite an example where CPI inflation has been very high and provocative (17% in April) — in the case of edible oils and fats, India reduced tariffs on palm oil , soybean oil and sunflower oil, but customs duties on rapeseed and cottonseed oil remain prohibitive at 38.5% for crude and 49% for refined. The domestic price of mustard oil has increased by more than 47% in the last two years, world prices even more, but our import duties remain at astronomical levels in the name of atmanirbharta. It does not work.

If India is to be atmanirbhar (self-sufficient) in critical commodities where import dependency is unduly high, it must focus on two oils – crude oil and edible oils. In crude oil, India is almost 80% dependent on imports and in edible oils, imports represent 55 to 60% of our domestic consumption. In both cases, agriculture can help. The massive production of ethanol from sugarcane and maize, especially in eastern Uttar Pradesh and northern Bihar, where water is abundant and the water table is replenished every two years approximately by light flooding, is the way to reduce dependence on crude oil imports. And in the case of edible oils, a large program of palm plantations in coastal areas and the northeast is the right strategy. A start has been made on these lines. You have to double it. But if we want to sustainably control food inflation, we must invest in increasing productivity and making agricultural markets more efficient. There is no shortcut.

Gulati is professor of the Infosys chair for agriculture at ICRIER

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