Shed fiscal policy rigidity
Inflation numbers for May — Consumer Price Index (CPI) has crossed the Reserve Bank of India (RBI) threshold of 6% and Wholesale Price Index (WPI) is at an all-time high — have under-lined the precarious nature of the ongoing economic recovery
Inflation numbers for May — Consumer Price Index (CPI) has crossed the Reserve Bank of India (RBI) threshold of 6% and Wholesale Price Index (WPI) is at an all-time high — have under-lined the precarious nature of the ongoing economic recovery. As the second wave ebbs, and restrictions are eased, economic activity is picking up. But there is a paradox here. The Nomura India Business Resumption Index (NIBRI) jumped to 76 in the week ending June 13. It posted the highest week-on-week increase of 8.1 last week. But consumer confidence continues to be low, especially among the less well-to-do. High inflation at this moment will put a squeeze on household budgets and, therefore, demand. The burden will be especially severe for the non-rich.
A spike in price of essentials hurts even in normal circumstances. These are far from normal times. Labour market conditions are weak. Employment and wage earnings have not recovered to even pre-second wave levels. A large health spending shock during the second wave has destroyed household balance sheets for millions of households. The fiscal policy response ever since the pandemic hit has been largely pro-cyclical. Provisional numbers from the ministry of finance show that gross tax revenue went up in 2020-21 despite a GDP contraction. This was made possible by a sharp increase in taxes on petrol-diesel. Fuel inflation is driving both CPI and WPI, which grew at 11.6% and 37.6%, respectively, in May. Petrol-diesel prices were not as high as they are now, even when crude oil was trading above $100 per barrel. Brent Crude closed at $73 per barrel on June 14.
The government has justified the continuation of higher duties on the ground that it is essential for revenue mobilisation. But it needs to realise that it is crowding out private spending. It appears that the fiscal policy managers are banking on monetary policy to bail the economy out. While loan guarantees and cheap credit are instrumental in preventing destruction of productive capital, it cannot generate demand when consumer sentiment is low and companies are saddled with excess capacity. As inflation rises, RBI will be forced to withdraw the monetary stimulus. It is important to realise that pursuit of fiscal prudence at the moment will only lead to stagflation — low growth and high inflation.