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In omnishambles!

Inadequacy of monetary policy tightening in controlling ‘stagflation’ is exposed bare; the government must complement RBI’s efforts to rein in the scourge

In omnishambles!
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Retail inflation, based on Consumer Price Index (CPI), has remained above 6 per cent since January 2022, and it was 7.41 per cent in September. The high inflation rate in Q2 FY 2022-23 follows high inflation in the previous two quarters. It is alleged that the high fuel and food prices and their spill-over to other sectors have sustained the high inflation rate. As per the mandate given to the Reserve Bank of India (RBI) by the Union government, the central bank is required to ensure that the retail inflation remains at 4 per cent, with a margin of 2 per cent on either side.

RBI has been aggressively raising the key interest rate, since May, to contain inflation. But till now, its monetary measures have failed miserably. The central bank had raised the repo rate by 40 bps in May and 50 bps each in June and August. During the last six months, RBI has hiked the short-term lending rate by 190 basis points. The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), on September 30, 2022, increased the repo rate by 50 basis points (bps) to 5.9 per cent, making loans expensive. The MPC has also lowered the growth projection for FY23 from 7.2 per cent to 7 per cent.

Apparently, RBI has realised that its policy interventions have failed to contain inflation. Only monetary policy won't work. It demands more serious efforts – a combination of both fiscal and monetary policy is required. Last week, MPC member Shashanka Bhide's comment on this issue is a case in point. In an interview with The Hindu, he said, "the high inflation rate in the last three quarters is mainly a consequence of the 'exogenous' price shocks, and addressing the issue will require coordinated policy efforts. The Covid-19 pandemic also presented challenges on the global scale, affecting trade and supply chains". Adding to this, the new challenges that are now emerging include slowing down of export demand, financial market volatility, and the uncertainty consequent to the Russia-Ukraine war. This statement by an MPC member reflects RBI's assessment about the oddity of the current inflation. It is a 'cost push' type inflation (unlike the typical 'demand pull' type), caused mainly due to disruptions in the global supply chain. But higher borrowing costs due to increased repo rates will bloat the inflationary spiral instead of containing the same. Higher production costs will also make Indian goods less competitive in the export market.

It may be recalled that in 2009-10, RBI faced a similar inflationary situation. Hope, RBI learns from its post-2009 handling of high inflation when, by March 2010, it had soared to nearly 10 per cent. It turned out that, contrary to expectations, food inflation was indeed influencing other prices. But the RBI didn't want to raise interest rates then as it would have endangered India's nascent post-financial crisis recovery. It felt the rise in inflation could be explained by "exogenous" (external) factors, and expected things to go back to normal after a "temporary phase", reports The Wire.

But why has RBI resorted to a different strategy in 2022 when the economy has not yet recovered from the COVID-19 crisis and the inflation is triggered by cost-push factors which are 'extraneous' by nature? The reason is, RBI blindly follows the US Federal Reserve's monetary policy moves. Recently, the US Fed has delivered consecutive rate hikes to take the target interest rate to 3.75-4 per cent. On November 2, the US Federal Reserve hiked interest rates by another 75 basis points in a bid to cool down persistent inflation. The move was on expected lines as the inflation number for September came at 8.2 per cent, over four times the target set by the Fed, reported Business Today. The Central banks of the UK and the EU have also gone for rate hikes to tame inflation.

The latest US Fed rate hike, on November 2, is the fourth in a row and, still, there is no indication as yet, that inflation is coming down as fast as the Fed would have wanted. Now the fear is that the continued rate hikes may push the country into recession. In September, the World Bank warned that as central banks across the world hike interest rates in response to inflation, the world may be edging toward a global recession in 2023 and a string of financial crises in emerging markets and developing economies.

Inflation or stagflation?

For India, inflation is not the only problem, and cannot be addressed in isolation. The real problem has to be identified clearly before taking any policy measure.

Economist Kaushik Basu, the former chief economic adviser to the Government of India and former chief economist of the World Bank, thinks India is already in the grip of stagflation. On February 15, he tweeted: "India's WPI (wholesale price index) inflation now exceeds 12 per cent for 4 months. It's not been this high in 20 years. There is overall growth but the bottom half has negative growth and youth unemployment is at an all-time high. What we have is a strange phenomenon—stagflation for the bottom half".

In an interview with The Week, Professor Basu observed, "The challenge India is facing becomes obvious when you look at the growth and inflation data together. Growth is low but positive. However, it is almost certain that this is because the rich are becoming so much richer. From what the Oxfam study shows, the bottom 84 per cent of India is showing negative growth. In short, India is facing an unusual situation, what I would describe as 'gated stagflation' whereby, the well-off are doing fine, with stagflation confined to the middle and lower-middle classes. Since stagflation refers to inflation combined with negative growth in the whole nation, India is not in stagflation. But the bottom 4/5th of India is clearly caught in stagflation. This is a novel phenomenon and needs to be analysed and dissected in order to devise policy. Policy attention, at least in the immediate context, has to be directed to curing India's crisis of gated stagflation."

Few macro-economic Indicators

In April 2022, the inflation of household goods and services (CPI) was found to have surged to an eight-year high of 7.79 per cent and, in September, the rate of inflation was 7.41 per cent — much above the government's target of a maximum 6 per cent. It may be noted that WPI is much higher than the CPI in India which indicates that the retailers are unable to pass on the increased cost to their ultimate customers — due to sluggish demand.

Over the years, the Indian rupee has declined steadily against the US dollar. Between 2008 and 2022, Indian rupee depreciated by over 50 per cent against the US dollar and, on October 19, its value was as low as Rs 83 for the US dollar. Business Standard reported that the Indian rupee is the worst-performing currency among the major South- and East-Asian currencies.

During the two-year period from 2020 to 2022, the annual compound growth rate of India's national income has been 0.7 per cent. The World Bank, on October 6, projected a 6.5 per cent growth rate for the Indian economy in 2022-23 — a drop of one percentage point from its June 2022 projections, citing the deteriorating international environment. The IMF has projected a growth rate of 6.8 per cent in 2022, compared to 8.7 per cent in 2021, for India. As per a report by Economic Times, the United Nations Conference on Trade and Development (UNCTAD) expects the Indian economy to grow at 5.7 per cent in 2022 and 4.7 per cent in 2023.

In addition to the low growth and widening inequality of wealth among citizens, data show that India's unemployment is very high. As on November 2, 2022, India's unemployment rate stood at 7.66 per cent — 7.31 per cent in urban and 7.82 per cent in rural areas. The data show the unemployment rate rise in October is accompanied by a fall in the labour participation rate (LPR), which fell from 39.3 per cent in September to 39 per cent in October.

In the first half of FY23, India's external sector was less well off, with a 96 per cent year-on-year surge in merchandise trade deficit at USD 148 billion. Contributing to this high trade imbalance was the slowing of merchandise exports and the consistent rise in imports. During April-September 2022, merchandise exports increased by 17 per cent and imports by 39 per cent year-on-year. More significantly, in September 2022, export growth had dropped to 5 per cent, while imports had expanded by nearly 9 per cent, reports BusinessLine.

The above indicators suggest that currently, the Indian economy is facing multiple challenges — a high rate of inflation, a slow and highly skewed growth rate, a fast-depreciating currency, and a high rate of unemployment along with a declining labour participation rate (LPR). In October, LPR declined to a mere 39 per cent. All these data reveal signs of stagflation are distinctly visible in India. Moreover, the World Bank's Global Economic Prospect Report (June 2022) cautioned about looming stagflation risk amid a sharp slowdown in growth. According to the report, the current crisis resembles the 1970s in three key aspects: (i) persistent supply-side disturbances fuelling inflation, preceded by a protracted period of highly accommodative monetary policy in major advanced economies, (ii) prospects for weakening growth, and (iii) vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.

Nevertheless, RBI and the Ministry of Finance are in denial mode. They say India's economy is better placed than many other countries to avoid the risk of potential stagflation! But data on various macroeconomic parameters do not substantiate their claim.

Quite remarkably, the RBI's Monetary Policy Committee (MPC) met on Thursday to deliberate on, and draft a report to the government following the panel's failure to achieve its inflation target of 4 per cent. Retail inflation has remained above the MPC's 4 per cent target for 36 months. The RBI Act stipulates that in its report, the RBI must explain the reasons behind its failure, the remedial steps to be taken, and a timeline for consumer prices to return to the target. Recent comments by the RBI management as well as publications by the central bank suggest that it will take two years for inflation to head back to 4 per cent. Though the outcome of the MPC meeting is not yet disclosed, the Business Standard has revealed that a major reason that is likely to be cited for inflation failure is the surge in global commodity prices caused by the Ukraine war! By definition, stagflation occurs when there's high inflation in an economy that is stagnant or contracting and unemployment is rising. In stagflation, demand isn't strong, while inflation is sparked by a sharp increase in commodity prices, often brought on by a supply disruption. Apparently, the RBI has realised that they have wrongly diagnosed the ailment as inflation while India has been struggling, for a long time, to cope with stagflation.

How to tackle stagflation?

According to the World Bank's latest forecast, global growth is projected to slow by 2.7 percentage points between 2021 and 2024 – more than twice the deceleration between 1976 and 1979. David Malpas, the President of the World Bank Group, has presented a 'supply

solution to stagflation', cautioning that unless major supply increases are offered, the pain of stagflation could persist for several years. The World Bank Report asserts that reducing the risk of stagflation will require targeted measures by policymakers worldwide. In an extraordinary era of overlapping global crises, policymakers everywhere will need to focus their efforts on five key areas:

⁕ First, they must limit the harm to people affected by the war in Ukraine.

⁕ Second, policymakers must counter the spike in oil and food prices. It is essential to boost the supply of key food and energy commodities.

⁕ Third, there is an urgent need to step up debt-relief efforts. Debt vulnerabilities were acute for low-income countries even before the pandemic. As debt distress spreads to middle-income countries, the risks to the global economy will grow in the absence of rapid, comprehensive, and sizeable relief.

⁕ Fourth, officials must strengthen health preparedness and efforts to contain COVID-19.

⁕ Fifth, the transition to low-carbon energy sources must be accelerated.

It is argued that when an economic shock comes from outside, as now and in the 1970s, "there's very little that conventional policy instruments can do to prevent it causing distress," says Iain Begg, professor of European institutions at the London School of Economics. "The best hope is to avoid inflation becoming self-propelled and for governments to target support packages at the worst-off, to prevent them descending into poverty and food banks, and to work on supply-side responses.", he added. In such a situation, a tighter monetary policy, as observed in the case of India and the USA, does not serve the purpose.

Fortunately, the Indian government has finally realised that inflation management cannot be "singularly" left to the monetary policy, as a majority of activities are outside its purview in the current context. Recently, Indian Finance Minister Nirmala Sitharaman made this comment at a seminar organised by the economic think-tank Indian Council for Research on International Economic Relations (ICRIER). She also reiterated that both the fiscal policy and the monetary policy have to work together to contain inflation.

Conclusion

Stagflation cannot be tackled with a tight monetary policy. It will prove counterproductive. The Government of India must take a few important policy measures to tackle the crisis before it goes out of control.

First, reliance on imported crude oil has to be reduced by restricting its demand. More thrust should be on public transport, especially on railways. Production of indigenous coal should be increased until a viable alternative energy source is found. India should seriously consider reversing the decision of decontrolling market prices of petrol and diesel by the previous government. Agreeing with the demand of the Opposition parties, the Parliamentary Standing Committee on Petroleum and Natural Gas had decided, in October 2021, to examine the pricing, marketing, and supply of petroleum products, including natural gas. The MPs argued that "decontrol" of the market prices has burdened the people as oil companies were unwilling to reduce the prices even though the international price of crude oil was low, reported Millennium Post. The administered pricing mechanism, based on the cross-subsidization of petroleum products, to distribute fuel at a lower price to food and export-oriented sectors must be introduced at the earliest.

Second, the falling rupee can be arrested only by exporting more goods and services than imports. To achieve this challenging task, India must formulate a long-term industrial and foreign trade policy. Merchandise goods must be made globally competitive. Third, to reduce huge income inequality and address the stagflation faced by around 84 per cent of the country's population, the government must impose a wealth tax on the super-rich citizens and redistribute the wealth to the poor and low-income earners through appropriate fiscal programmes.

Fourth, the government has to create jobs. The neo-liberal policies which contribute to 'jobless growth' must be discarded. Unless pro-poor programmes are initiated by the government, stagflation will stay and 84 per cent of India's non-elite citizens will endure the worst suffering.

Views expressed are personal

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