Fighting inflation not just RBI’s responsibility

The assumption of monetary policy being the sole or primary instrument for containing inflation is wrong on several grounds, theoretical as well as empirical. The primary assumption here is that inflation is in most cases a monetary phenomenon, driven by easy liquidity with too much money chasing too few goods. While this may be the case in several developed countries, it is not true in the case of India. The one-size-fits-all solution ignores the nature of inflation, which may differ across countries. While some part of inflation in India is driven by external factors, such as the rise in global fuel and commodity prices along with exchange rate volatility that contribute to imported inflation, inflation lately has been largely driven by local food prices. Unlike fuel and commodity prices, which are driven by international price movements, food inflation is largely domestic. In fact, globally, food prices have moderated from their peak levels for all major food groups. In India, on the other hand, a large part of today’s inflation is driven by food. This inflation accounts for almost half of the total inflation since June 2022.

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Within the food group, it is cereals which have seen a rally, with their inflation rate crossing 10%. Most of this is driven by wheat and rice. With an expected shortfall in rice production due to unseasonal rains and a deficient monsoon in major rice-growing states after a shortfall in wheat production, the inflationary trend for cereals has been strengthened. Another factor that is likely to put upward pressure on food prices is unprecedented inflation in farms inputs. While overall wholesale price inflation has been above 10% for more than a year now, for a major part of this year, inflation in farm inputs has been above 30%. The rising cost of cultivation will add to food inflation.

While the outlook for food inflation is not very positive, monetary policy and interest rate increases will not have any impact on it. That also raises the big question of the role of fiscal policy in containing inflation. The onus of reducing inflation is as much on fiscal policy as on monetary policy. There is now growing consensus in the economic literature of different persuasions that an effective approach to containing inflation requires an equally important role of fiscal policy. In India, too, this is important, given the nature of inflation and our growth challenge. India’s economy is still recovering from a slowdown before the pandemic followed by covid disruptions. In a demand-constrained economy, the role of fiscal policy becomes even more important. The rural economy is already in distress, due to a fall in real wages over the last two years. Inflation in farm inputs has further eroded the earnings of cultivators.

It is here that fiscal policy can help in not just sustaining growth but also containing inflation. Fiscal measures that lead to an increase in the deficit and government debt may be inflationary in a situation of excess liquidity and demand. However, increased expenditure for reviving demand is unlikely to be inflationary if it is met by increasing government revenues rather than by using the deficit route. On the other hand, progressive taxation can not only deliver much-needed revenue, but also contain excess demand for conspicuous consumption, a role traditionally assigned to monetary policy.

The last decade has seen countries suffering from unnecessary austerity measures amid tax breaks given to the corporate sector to boost growth, with neither growth gained nor inflation contained. India took the same route, giving massive corporate tax waivers with little to show in terms of private investment growth. It is high time the government looked at fiscal measures financed by progressive taxation to boost growth. This must complement monetary measures in India’s effort to contain inflation and revive growth.

Himanshu is associate professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi.

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