Inflation management needs salutary changes

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Inflation management needs salutary changes

Tuesday, 21 March 2023 | Sumeet Bhasin

Inflation management needs salutary changes

The Reserve Bank of India’s MPC will meet in the first week of April. The stakeholders are concerned if it will emerge wiser from recent global experiences

Vietnam became the first country to break ranks with the global community to cut the policy rates. The Central bank of Vietnam surprised the global economists to cut the benchmark interest rate. The East Asian nation was wary of the fact that the blind-walking alongside the US Federal Reserve to keep raising the interest rates would have surely taken its economy into fast downturn.

Europe remains hawkish with rate hikes, increasing the policy rate by 50 basis points last week. Jerome Powell, the head of the US Federal Reserve, has come under intense fire within his country. He is being accused of walking the US economy to the doorsteps of a deep recession. He has been dogged in pursuit of higher interest rates despite fellow members cautioning him of risks associated with hawkish measures.

Within a span of a few days, three banks in the US have come to their knees, with one collapsing in 48 hours. The US and Europe are now battling the worst fears of economists of banks failing the high interest regime. The monetary policy meeting (MPC) of the Reserve Bank of India will meet in the first week of April. The concerned stakeholders are watching out with intense curiosity to see if the MPC of the RBI will be wiser from the immediate global experiences of following a hawkish path.

Inflation indeed is a cause of concern. The poor suffers the most from an uncontrolled inflation. Therefore, there is an unequivocal understanding that inflation must be tamed with all the policy might available at the RBI and the government.

But it must not be ignored that high interest rates may be suicidal for the economy, as a number of factors make it less effective at controlling inflation, while harmful economic growth more. High interest rates drive away capital, which may exacerbate inflation further, while harming emerging economies more by putting pressure on their currencies.

Several studies and reports have taken note of the creditstress, harming small businesses and low-income households, who are most sensitive to changes in interest rates, while being at loan repayments risks when rates are high. Also, economic growth naturally takes the blows of high interest rate regime, as private investment and private consumption take backseat in the economy.

Furthermore, increasing interest rates may not address the underlying causes of inflation, which can be caused by a range of factors, including rise in the money supply, high production costs, or changes in consumer demand. For instance high cereal costs in India is driving inflation high. Indeed, core inflation is also staying above six per cent. But cereal and fruits are making the management of inflation a daunting task. India indeed needs to take steps to work on post-harvest management with the participation of the private capital to ensure that the cereals, fruits and vegetables don’t march on high price trajectory to give fresh legs to inflation.

Thus, it’s incumbent upon the policymakers to consider targeted interventions to address specific drivers of inflation. The government has done well by proactively asking the Food Corporation of India (FCI) to auction the public wheat stock in the open market. The four rounds of the auctions of the wheat stocks have shown sobering impact on the wheat prices, which have significantly cooled down in the last few days.

Similar interventions are needed to cool down the prices of the specific drivers stepping up the inflation. The price stabilization fund, which is a mechanism created by the Centre, to deal with the volatility in the prices of food items needs effective utilization. This has to be done by the state governments with effective utilization of the market intelligence architecture. It will be worthwhile to explore if there could be a mechanism to incentivize the states for better performances on the price stabilization front. 

Failures among banks, including Silicon Valley Bank (SVB), have been attributed to a variety of factors, with high-interest rates bring the principal culprit, which has proven to be unsustainable and even disastrous. Banks resort to offer high-interest rates to attract depositors in pursuit of rapid growth. But the banks tend to gain customers who are primarily interested in the rate, leading to a higher concentration of risky or unstable deposits. This makes banks becoming host to hot money, which can make a sudden flight from the first sign of stress, as had been the case with Silicon Valley Bank and other regional banks in the US.

By all accounts the RBI will not be able to meet the projected inflation rate of 5.7 per cent for this fiscal. This will be possible only if inflation crashes by over 230 points in the last month of the financial year. This will call for the RBI to explain why it failed in the inflation management as mandated by Parliament. We already know that couple of the members of the MPC had opposed the Repo Rate hike in the last meeting. Therefore, it will be desired that the RBI embraces a course correction in the light of the fresh developments globally.

Pausing the rate hike trend will be most desired by the stakeholders. Cut in the rate hikes will, however, be the demand of the prevailing situations. Also, the fact that India had not resorted to printing of currencies to deal with the situations arising out of the Covid-19 pandemic may be factored in since the market is not flush with cash that requires to be sucked out. Indeed, the US and the European nations had excessively printed their currencies to deal with the economic crises due to the pandemic. They may require flushing out the excess cash from the system to control the inflation. This is surely not the case in India.

But it must not be forgotten that India has paid a heavy prices for such quick-fix approach of the government to deal with the situations arising out of the economic crisis. The UPA government led by Manmohan Singh, former prime minister, had done exactly the same thing, of giving cash in the hands of the people in its bid to find an easy way out of the economic crisis, which India faced in the wake of the 2008 global crisis. This had led Indi to double-digit food inflation for the remainder of the term of the UPA government. It was only when Narendra Modi took charge of the country as the prime minister that the Central government could tame the runaway food inflation with agile policy making.

The weather scientists have warned that India may have to face El Nino this year. There may be a risk of weather pattern disruptions, which could also have bearing on prices of several items, which constitute the retail inflation basket. This also calls for the RBI to elicit wider participation in the process of the inflation management, since some of the solutions may lie in the domains of the Centre and the state governments.

It must be understood that working in silos is an ailment that made India suffer the most. The RBI must make sure that it’s not working from silos.

(Author is a policy analyst)

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