Inflation fight undermined

India’s official inflation rate for the month of August is 6.83 per cent, down from 7.44 per cent the previous month. It is still above the 6 per cent 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 2-6 per cent for the consumer price index (CPI). This is the seventh time in the past 12 months that the monthly inflation rate is above 6 per cent.

Is that not disconcerting for the RBI’s Monetary Policy Committee (MPC)? It needs to tighten money supply further to reduce inflation. But it has chosen to keep the interest rate unchanged, hoping that inflation will come down by itself. The RBI Governor has indicated that inflation will remain high for some time. 

India’s consumer price index consists of a weighted average of around 450 items in the consumption basket (different for rural and urban consumers). But almost 49 per cent of the weight goes to food and related items. Hence, if food inflation is high, naturally the overall inflation is high. Food inflation is currently running at 10 per cent, thanks to rising prices of vegetables, oilseeds, pulses, milk, and even cereals.

The government has used a combination of banning exports or levying a hefty export tax on a variety of agricultural products, including wheat, rice, sugar and onions. This affects the earnings of farmers who were eyeing lucrative profits from exports.

For instance, India exported 7.4 million tonnes of parboiled rice in 2022,  but now there is a stiff 20 per cent export duty in place. India accounts for 40% of the world’s rice exports, and thanks to India’s curbs, this has created additional scarcity in the world. India’s export curbs 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, 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% 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 that 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.

Going beyond food inflation, the outlook for crude oil also anticipates high prices. Due to supply cuts by Russia and Saudi Arabia, oil prices have crossed $85 a barrel, and will stay high. Since this affects India’s imports adversely, there is a possibility that the rupee will further decline from 83 to 85 to a dollar. The oil import 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 Rs 4.5 lakh crore. The cabinet recently announced a Rs 1.7 lakh crore revival package for BSNL, the debt-ridden telecom company. In the past seven years, as per an answer to a parliamentary question, nearly Rs 15 lakh crore 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 paying 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 industrial projects.

India tried very hard to curtail deficit-spending tendency, by trying to make it illegal to exceed a certain limit. The Fiscal Responsibility legislation passed by parliament in 2003 made it illegal to exceed 3% of 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.

(The writer is a noted economist)