Education

The way to rein in inflation

Anis Chakravarty | Updated on March 09, 2018

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Mr ANIS CHAKRAVARTY

If certain policy measures are initiated from a long-term perspective, inflation can be tamed to more manageable levels.

Amidst stubborn inflation, the Reserve Bank of India (RBI) raised policy rates by 25 basis points on June 16. Following on a 50 bps increase in May, this has resulted in a 75-bps-increase in 2 months and a 275-bps-increase since March 2010. Overall, the RBI has intervened 10 times since last year to quell inflation. This begs the question – is the monetary policy having the desired effect?



The RBI has previously acknowledged that effectively managing inflation through monetary policy is a challenge due to the persistence of a large fiscal deficit. Further, questions have been raised whether high long-term inflation is moderating growth and investment. With clearly receding GDP figures, thoughts are being raised that the RBI's persistent intervention can have an adverse effect on the long-term health of the economy and the sustainability of the growth story.



If fiscal measures for price stabilisation are not an option, declining economic growth in light of determined rate hikes a worry and consequences of monetary policy ineffective, a larger question is what exactly is required to tame the high inflation ?



Perhaps it will help to seek answers in the root cause of inflation.



Perhaps the first priority is a major, if gradual, cut in public expenditures. Government spending and administration must be brought in line with taxes if monetary equilibrium is to be restored to the inflationary economy. A proposal deserving serious consideration is comprehensive indexation. In this process, all contracts are adjusted to factor in prevailing inflation rate, such that it is clear where real prices stand and nobody tends to “overbid” for inflation which in turn influences the government to produce more inflation. Personal tax could be easily adjusted so that rates are tied to the cost of living and any deductions and exemptions are computed as per the inflation. These measures were adopted in Canada and in certain European countries. Government securities could also be indexed keeping the interest rates floating and linked to the rise in the cost of living, rather than a flat percentage. One drawback is that high quality data are required to propose an indexation base. Currently in India, the data that is gathered by the Central Statistical Organisation have certain limitations. Data procurement and analysis would require considerable improvement if one is to implement such indexation policies. However, the benefit of this in the long run is substantial.



Thirdly, if inflation in India is primarily a supply side issue, policies should be adopted to minimise price destabilisation effects and ensure supply challenges are being met. Structural measures such as better infrastructure and empowering more private initiatives are required to improve agricultural supply response. Another key issue is food security and the efficacy of the public distribution system in India. The linkages between food security and inflation cannot also be ignored.



Another clear area of concern is the level of subsidies provided by the Indian government. Though this may seem beneficial and welfare-oriented, such subsidies put a huge burden on the country's fiscal deficit. Subsidies benefit the larger consumer, which in essence mean the economically better-off members of society. Inflation is often perpetuated and spread through the reluctance of governments to change the existing economic institutions.



In India, inflation is often viewed in a myopic way and the larger picture is rarely considered. It is important to recognise that inflation in itself is not bad. When inflation becomes chronic and integrated in the growth itself do problem arise. If certain policy measures are initiated to address this issue from a long-term perspective, it will go a long way in bringing inflation down to more manageable levels and in the end keeping the India growth story alive.



The Inflation Question – Is there a way out? Anis Chakravarty



Reference Information:



If certain policy measures are initiated from a long-term perspective, inflation can be tamed to more manageable levels.



(The author is a Director, Deloitte, Haskins & Sells.)

Published on July 24, 2011

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