Should the government loosen its pocket?

What is your view on the current trend in price inflation?

NR Bhanumurthy: Firstly, when it comes to retail inflation, the latest reading says it is somewhere close to 5.6%. The Reserve Bank of India (RBI) has already predicted that it will remain below 6% till the end of March. However, many of us believe that there is some upside risk when it comes to inflation and inflation expectations. This is for two reasons. One, this week international oil prices have risen to $87 a barrel. We also see increasing inflationary pressures around the world, especially in countries that had a large fiscal stimulus. Therefore, there may be a risk of transmission of international inflation to the domestic economy. But at the same time, one really needs to understand what drives this inflation. At least in the Indian context, supply side constraints play a major role and require a different policy prescription. And I am quite sure that RBI has many tools to control this inflationary pressure. For the last three quarters, the RBI has been bullish when it comes to inflation forecasts, so I think it is likely to be true when it says retail inflation will be below 6%. With regard to the Wholesale Price Index (WPI), I have been a little wary of this reading. You can’t have the wholesale market price and the retail market price indistinguishable for very long. We generally expect the transmission between the wholesale market and the retail market to be no more than a month or two. But what we are seeing now is a very long divergence. We need to look in a little more detail in terms of coverage and items and all that stuff. We need to focus more on consumer price index (CPI) and less on wholesale prices.

Himanshu: We have to be very careful not only in looking at inflation data as a whole, but also in looking at the factors that drive inflation. I think most inflation is fundamentally driven by supply. Also, it is not driven by domestic factors as much as it is by international factors. But domestic factors have added to the problem. The most obvious factor is the increase in taxes on petroleum goods and services. Therefore, domestic factors have contributed to inflation, but inflation is mainly driven by the supply side. But I would also be a little hesitant to say that very little can be done using fiscal policy.

Second, I think the difference between WPI and CPI is huge and it has been like that for a long time. Some of the inflation in wholesale prices will be passed on to consumer prices, so inflation is a cause for concern not only for fiscal policy or monetary policy, but also for the overall health of the economy as inflation continues to impact the basic economics of households.

How do you see the role of fiscal policy in supporting the economy in an environment of high inflation?

NR Bhanumurthy: Talking about fiscal policy, the current year is proving to be a very good year in terms of tax revenue. If you look at the last budget, the government focused on a medium-term outlook, leaving short-term issues for the central bank. I am hopeful that the same macro framework will continue in the coming budget. But at the same time, the measures that were taken to help the poor in terms of providing a safety net continue. Right now, the government has fiscal space and would like to focus on the medium-term growth prospects along with the social sector. Ultimately, the biggest incentive will be any solution that provides more employment opportunities. Economic recovery should be on a more sustainable basis in the form of short-term spikes in growth.

editorial | inflation puzzle

Himanshu: I think it should cost more. If there is any time that the government should spend more, it is now. This obsession with managing the fiscal framework has to go beyond. If fiscal prudence slows growth, I don’t think it’s something sustainable. The reason I say this is that the government’s own economic indicators are sufficient to show that there is excess capacity in the economy. Aggregate consumption, which constitutes a major part of GDP, is slowing down and has been for some time now. I think the focus should be on reviving the economy at this point of time and this is best done by using fiscal policies. The government has to open its purse, not only in terms of improving people’s income in cases where it can do so directly, such as using social security schemes, but also increasing transfers to the states. We are actually reaching a situation where the public debt to GDP ratio is going to increase because if growth is going to slow down, it will basically mean that government revenues will also slow down. So, I don’t see how it would be good fiscal policy if growth is going to be impacted by fiscal prudence. I recommend that we don’t worry about fiscal deficit at this juncture because once growth picks up, a lot of fiscal issues can be taken care of. But if the economic engines aren’t activating, you’re getting into a vicious circle, and then I don’t think any kind of fiscal management, in the short or medium term, is going to be sustainable. So, I think we need the government to play a vital role in reviving the economy.

How would you respond to people who talk about the risk of stagflation?

NR Bhanumurthy: I think they are getting cautious for one simple reason. We, at least in India, have a general consensus that the true inflation number that is relevant to the household is the retail inflation number. WPI is a very fragmented indicator that excludes services and other things. So, let’s be clear that if we have to look at one number to measure inflation, it is CPI inflation. And CPI inflation is within RBI’s target range of 2% to 6%. When it comes to the faltering Index of Industrial Production (IIP), it should be noted that IIP covers a very small component of the industry. IIP is a very crude leading indicator. So, I don’t think we need to decide on the basis of IIP numbers. My own assessment is that we are nowhere near stagflation. In fact, for the next fiscal year, my own prediction for GDP growth is somewhere close to 6.5%-7%. And if we look at exports, there has been a lot of growth in exports, so the recovery seems to be very, very fast. If we can continue with the fiscal framework adopted in the last budget, I think we should look at 7% GDP growth for the next year. And as we’ve already discussed, inflationary pressures are definitely there. It can be somewhere close to 6%. So, I wouldn’t really support the argument that we are anywhere close to a stagflation recession.

Himanshu: Stagflation may be a very strong word, but I think there are definitely pressure points. Inflation and low growth tend to persist for a long time, I don’t think we can completely deny. As far as I disagree with Bhanu, he is with his optimism as far as the growth prospects are concerned. At least when it comes to economic data from what I can see, it is not something that is very easy to deal with. Right now a lot of inflation is still coming from the supply side. But if the economy bounces back after the pandemic is over, it will not lead to a moderation in inflation; This can actually aggravate the inflation situation.

Second, I am again not so optimistic as far as the growth figures are concerned. I am not going to make any predictions on the growth figures for next year because in this crisis situation, most of these numbers are affected by the base chosen to calculate these numbers. I think it will take some time for us to get back to normalcy. Until we get back to normalcy, I think all these numbers don’t make much sense; They’re just bouncing up and down. In the broadest sense, the threat of high inflation and low growth to persist, at least for some time, is real. A lot depends on how the government reacts to the situation in terms of reviving demand in the economy, but also in terms of managing inflation. These are issues for which we still do not have a conclusive answer.

Is there anything the Budget can do in terms of structural reforms to address supply-side inflation?

NR Bhanumurthy: I’m not really sure whether fiscal policy can directly address inflation driven by supply side factors, except perhaps by reviving growth. But to go back to an earlier point, if we look at the advance estimates of GDP, they suggest that the investment rate is somewhere close to 36%, which is similar to the investment rate during high growth periods. Very close to what we saw. last decade. That’s one of the key indicators for me when I say we’re going to see 7% GDP growth.

Himanshu: There is not much that the government can do. But it certainly does what it can to protect demand, the economy, the middle class and especially the poor and vulnerable from the effects of high inflation. I think this is the role of the government. For example, taxation on petroleum products is something that is part of fiscal policy. So, this is something that the government can influence. When it comes to fertilizer prices, which are rising very fast, the government can increase its contribution and thereby reduce the prices being paid by the farmers. Remember, the cost of inflation is not just a direct cost, it can also be passed on indirectly to other prices and can have a very debilitating effect on the economy. Industry, such as the automobile sector, may start passing its high input costs on to the retail sector, ie consumers. This is where I think the government can really step in and reduce the impact of high inflation on the industry as well as consumers by reducing direct and indirect taxes. This is something that will have an impact on the demand side and the revival of the economy as a whole. Therefore, I do not think that the hands of the Government are completely tied; It certainly has a role to play. The government should look at the long-term picture rather than the short-term picture of generating revenue by levying higher taxes. Instead people should be allowed a larger disposable income so that consumption increases in the economy. And one way to do this, in addition to income transfers, is to reduce taxes on goods and services that are seeing high inflation.

Himanshu is Associate Professor at Jawaharlal Nehru University; NR Bhanumurthy is the Vice Chancellor of Dr. BR Ambedkar School of Economics University