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Photo: Mint

The policy conundrum that stagflation poses

RBI has seen inflation hover above its tolerance limit for three successive months now. Even if it’s able to quell its imported component, India may not be able to escape difficult choices

When India went into lockdown back in March, inflation was not even a blip on our anxiety radar. Today, we must worry about “stagflation", a term that signifies the odd rise of prices amid economic stagnancy. Retail inflation had broken above the Reserve Bank of India’s (RBI’s) tolerance limit of 6% in June, and rose to just above 6.73% in July, but it has taken August’s figure of 6.69%, out on Monday, to confirm its persistence. As before, a closer look at the data shows buoyant food prices as a significant contributor to inflation, with protein-rich items getting especially dearer. Such a price uptrend, however, cannot be analysed on an item-by-item basis without taking monetary conditions into account. Inflation, after all, is a sign of excessive money vying for too few goods and services. This complicates any policy that pumps more of it into the economy.

Efforts to pin overall inflation down to its causes are not easy. An obvious culprit would be the covid clamps that snapped off supplies. While these have mostly been eased, not all supply chains have been fully restored, so this squeeze could have outweighed a slump in demand after the pandemic took hold. Food items have been under specific watch. Here, while bounteous monsoon rains have brightened prospects of a bumper harvest this year, the output of protein-rich staples may still fall short. Also, a slow resumption of transport and other points of friction could get in the way. Note that wholesale price inflation turned positive in August for the first time since March, a reflection of a recovery in the pricing power of producers. Apart from supply constraints, though, there is also the effect of RBI’s liquidity easing to consider. As a stimulatory measure, the supply of money has been upped ever since covid struck the economy, and our productive capacity may have failed to keep pace. Yet another suspect has been “imported inflation", which RBI spoke of recently. With global oil prices low and other imports weak, the central bank was probably referring to the inflation brought about by an influx of dollars from abroad. Till a few weeks ago, RBI was buying the US currency to keep the rupee stable, an exercise that pumps extra Indian currency into circulation, which then needs to be mopped up—or sterilized—through bond sales. If not, there would be excess cash around. Large inflows make sterilization difficult, for RBI’s bond supplies tend to push up market interest rates, which goes against its easy-money policy. In a reversal of stance, RBI appears to have decided not to intervene much in the foreign exchange market so that it gets a grip on internal price stability—a major part of its mandate.

So long as inflation stays above 6%, RBI would be wary of easing money any further. But if rate cuts might stoke prices, so could a fiscal stimulus by the Centre. With our economy in dire need of state spending, this puts our policy matrix in a fix. The government must take some hard decisions now. It could hope that RBI’s swerve to control the rupee’s internal rather than external value—with India largely open to capital flows, it cannot do both—bears quick results. This seems unlikely. Or it could go ahead with a fiscal splurge, as required, and hope for a revival that does not send prices soaring too high. Neither option is free of risk. But such are the hard times we’ve fallen upon.

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