India’s Options for Inflation Control

Indian policymakers should be commended for averting a deeper economic crisis than it could have been, but to safeguard the country’s recovery from COVID-19, they must act boldly to both boost demand and protect the offer, writes Raghbendra Jha.

During the first wave of the COVID-19 pandemic in March 2020, India experienced the longest lockdown in the world. Naturally, its economy took a massive hit.

During the first quarter of the 2020-21 financial year, India’s gross domestic product (GDP) fell by 23%, the biggest drop of any major economy in the world.

Most economists and international organizations have recognized that this is both a supply and a demand problem, but have offered mainly demand-driven solutions. All major countries in the Organization for Economic Co-operation and Development (OECD) have engaged in large-scale quantitative easing – when a central bank buys bonds or other assets on the open market in order to inject money in the economy in hopes of triggering growth or recovery – near-zero interest rates and other demand-stimulating policies.

India was also asked to take the same route, but wisely chose differently. His so-called “dumbbell strategy” – which focused on a combination of expanded social safety nets for vulnerable Indians and policy adjustments made in response to constantly updated real-time information – minimized the risk large-scale hunger and massive bankruptcies.

It worked and the economy showed signs of recovery throughout 2021, despite the terrible impact of the waves from the Delta and Omicron variants. This has continued this year and the strong growth is expected to continue into 2022-23. The pattern of spending in the budget indicates that the economic recovery has been supported by increases in public consumption and investment spending.

The monetary authorities are to be commended for keeping the main economic policy indicators under control and ensuring adequate liquidity during this period. In addition, bankruptcy law and other policy measures have ensured that the non-performing asset ratio – a loan a bank has made in the open market that is not repaid, a key indicator of economic performance – in public sector banks has fallen from 21% in 1994 to 7.5% in 2021. This is a sign that despite the pandemic, the climate for private investment remains largely improved in India.

However, another factor has come back as a major problem: inflation.

India’s inflation rate of around 6% is high. Although still below that of the United States and some other OECD countries, if sustained, this level of inflation could dampen the recovery in India.

While this is concerning, it would be safe to imagine what would have happened if the country had pursued a strong demand policy during the first wave. Rather than just inflation, it would have seen even worse “stagflation” – when higher inflation is accompanied by weak growth (usually due to stagnating supply).

Yet this is clearly a problem for India, so how do you tackle the inflation problem? What is the output?

It is clear that monetary firming should only be undertaken as a last resort. The country faces a structural problem of supply and demand that cannot be solved by monetary means alone.

When an economy faces both demand and supply shocks, targeting nominal GDP (GDP expressed in current prices, without adjusting for inflation) rather than targeting the inflation rate can give better results on average.

Therefore, at least for some time, India should focus on nominal GDP targeting, allowing inflation expectations to stabilize around the nominal GDP target and some stability for the economy. , and to revisit the issue of appropriate monetary policy in more normal times.

Second, some supply-side measures are needed. With the rise in the price of oil, largely due to geopolitical concerns, excise taxes imposed by central and state governments are keeping oil prices high and exacerbating the price situation – this could be a point departure.

On top of that, India needs to broaden its tax base. Unfortunately, just over one percent of the population pays income tax in India. This number must grow rapidly and substantially. One way to do this is to extend it to farm income – after costs have been established and subject to standard exemption limits, where they would only be taxed on farm income above a certain benchmark. .

Jthis would in turn give the government revenue to reduce excise duties on petroleum, and even consider subjecting petroleum products to a consumption tax. This would reduce inflationary pressures, raise incomes, lower the tax rate for the middle class, reduce the size of the informal economy and tax evasion, and provide other benefits.

Crises provide governments with a rare opportunity to implement far-reaching reforms. Reforms such as these – targeting nominal GDP, broadening the income tax base and, in turn, reducing oil excise duties – can both bring immediate relief to India’s population and, by tackling inflation before it gets out of control, improve India’s economic growth prospects. growth with lower inflation in the future.