Indian Economy In Danger Low Growth + High Inflation

Table of Contents

What’s happening?

India is now facing a dual problem of low growth and high inflation.
The recovery has proved much weaker than expected, with growth amounting to a meagre 4.1% in the fourth quarter of 2021-22.
At the same time, inflation has been surging so much so that over the past few weeks the government has taken a wide range of measures to deal with it.

Unfortunately, this strategy is misplaced.
The government’s actions will have only a marginal effect on inflation, while they may do significant damage to the incipient recovery.
The government needs to step back from the inflation fight, and instead encourage RBI to tighten monetary policy.

inflation

CPI inflation was close to 8% in April, nearly double RBI’s legally mandated target of 4%.
Most of this inflation is caused by supply-side bottlenecks, triggered first by the pandemic and subsequently by the Russia- Ukraine war and lockdowns in China.
Yet even as supply has been constrained, RBI has been pursuing an easy monetary policy, aimed at encouraging demand.
As a result, inflation has been increasing.

With inflation surging, and RBI still in “accommodative” mode, the central government has now announced a slew of measures to ease the supply constraints, Focussing on those commodities whose prices have increased sharply.
It has banned wheat exports, lowered the excise tax to Rs 8 per litre on petrol and Rs 6 per litre on diesel, and reduced the import duty on steel.
That’s not all. The government has also imposed an export duty on steel products at the rate of 15% and increased the export duty on iron ore from 30% to 50%.
It has imposed a cap on sugar exports. There is a demand to ban cotton exports as well.
It is clear that the government is trying hard to bring down the cost of commodities.

What experts say?

But these actions will only have a modest effect on inflation.
Part of the reason is that price increases are no longer confined to just a few commodities.
Inflation is now broad-based, extending to virtually every good and service in the economy.
Further inflationary pressure is building up, as seen from WPI inflation of 15%, the highest in more than two decades.
As these wholesale price increases are passed through to the retail level, CPI inflation could rise further.

Why will it have damaging effect on Economy?

India now faces a historic opportunity to use exports as a lever to boost GDP growth.
China, the main exporter, has been locking down its factories even as international firms are scouting for new production locations.
Meanwhile, Russia is being subjected to ever-tighter economic sanctions.
As a result, two large countries are reducing their presence on the international trade landscape, creating an unprecedented scope for India to attract international firms to produce and export from here.
Exploiting this opportunity requires an appropriate policy stance.
Perhaps the single most critical element of such a stance would be a stable and consistent trade policy.
Whenever the government suddenly bans exports or imposes export duties, it puts firms with export orders in a position where they cannot fulfil their contracts.
This is not only embarrassing, it also exposes both exporters and importers to large losses.
To avoid this situation, domestic firms will shy away from entering the export business, while foreign firms will be reluctant to place orders with Indian firms.
In addition, multinationals will be discouraged from shifting their production to India.
After all, why should a firm relocate here, if there is a risk that its exports could be banned, its imports subjected to high duties, and the rules governing its sector changed overnight?
Finally, the government’s actions will affect growth in yet another way.
The reduction in excise taxes on petrol and diesel will deprive the Centre of revenue at a time when the budget deficit is already far too large.
That means the government may need to compensate by cutting spending on infrastructure projects that are vital for the nation’s development.

Role of RBI

At this crucial juncture, macroeconomic policy has the delicate task of simultaneously tackling inflation and promoting the recovery.
The first task is the job of RBI. The central bank must take full responsibility for its actions so far, sending a clear signal that henceforth it will focus on bringing inflation down without
getting distracted by any other objective.
The government on the other hand needs to focus on growth.
It needs to reduce market interventions, eliminate prohibitions, and dismantle trade barriers, so that firms are incentivised to export and invest.
If instead, we continue to get the policy “assignments” mixed up, we will end up with objectives that are mixed up.
That is, instead of entrenching growth and derailing inflation, we will derail the recovery and entrench inflation.
That would not just be a policy mistake. It would be a recipe for a crisis.