How to address the inflation challenge - Hindustan Times
close_game
close_game

How to address the inflation challenge

ByJanmejaya Sinha
Jul 06, 2022 09:42 PM IST

The need of the hour is to control oil prices, both by buying oil cheaply from Russia and reducing taxes, continue with the divestment programme and accelerate spending on infrastructure

The impact of the ongoing Russia-Ukraine war on energy and commodity prices has caused great global economic turmoil. Some countries are facing food shortages and all oil-importing countries have been adversely affected. The invasion has come at an unfortunate time for India. Just when we had dealt with our double balance sheet problem and our corporate and financial sector balance sheets were looking strong, energy prices spiked, inflation increased, and interest rates started to rise, adversely affecting the start of the capital investments cycle in India. It is important to recognise that inflation in India is not the result of increased aggregate demand — capacity utilisation is still, on average, around 70% — but because of higher energy prices and supply chain disruptions. Thus, interest rate hikes cannot curb it.

This is an important economic period for India. The medium-term augurs favourably for India’s growth prospects and even its place in the world. We must all work together to seize the opportunity (Shutterstock) PREMIUM
This is an important economic period for India. The medium-term augurs favourably for India’s growth prospects and even its place in the world. We must all work together to seize the opportunity (Shutterstock)

Interestingly, inflation in the United States (US) and the Organization for Economic Co-operation and Development (OECD) countries is higher than it is in India. This has happened for the first time in living memory. The cause of inflation in the US is not because of higher energy prices (it is an oil exporter), but due to the massive economic stimulus to combat Covid-19. As a result, the Federal Reserve has been forced to start raising interest rates to moderate inflation.

The sharp increases in interest rates in the US have led to an outflow of funds from India, seriously impacting the exchange rate and causing the rupee to fall to an all-time low against the dollar. This puts the Reserve Bank of India (RBI) in a difficult position. Raising interest rates tends to curb demand even though aggregate demand is still soft. In fact, raising rates will delay the start of the capex cycle, which will affect the growth prospects of the economy, making the cure worse than the problem.

The basic equation for debt servicing is that if the nominal growth rate is higher than interest rates, the country can service its debt. If the growth rate falls below the level of interest rate, servicing the debt becomes much more painful, and requires reallocation in expenditure away from productive purposes. However, the sharp outflow of funds will put pressure on RBI, which has led it to raise rates to support the rupee. Navigating this situation is going to require deft handling and non-standard responses.

The finance ministry, RBI, and given the geopolitical situation, the ministry of external affairs (MEA) will need to coordinate closely. MEA has been adept in handling the Indian position till now, highlighting how India imports much less oil from Russia than most European countries. Additionally, it has stressed that India is dependent on Russian arms not just because Moscow has been a reliable partner, but because the West has been reluctant to supply arms to India. This robust narrative has allowed India to manage some strategic autonomy and not get isolated globally. However, much of the international press will continue to paint the Indian position badly and put a spotlight on the country, so the work must continue.

To address inflation in India today, the need of the hour is to control oil prices, both by buying oil cheaply from Russia and reducing taxes on oil to contain the price the consumer pays. However, lowering taxes will put pressure on the fiscal balance. To address this, the divestment programme cannot slacken. The fall in global indices will make this more problematic politically as price realisations will be lower. However, the alternative will be worse, and so, divestments must not stall. Waiting is unlikely to help, as the prospects for the global economy are fading with the expectation of a recession in Europe and the US rising, and the zero-Covid-19 policy in China has reduced its growth rate. The China-West tension is likely to dampen its economy’s prospects further in the medium-term. So, delaying divestments in the hope that the markets recover quickly may not be prudent.

The other elements that had been articulated in this year’s fine Budget must go on. Infrastructure spending should not falter; in fact, it should be accelerated. It will improve the productivity of the economy and generate demand by creating employment. If interest rates rise too much, this process will be adversely affected, and so deft navigation and full coordination between RBI and the finance ministry are essential.

In the medium-term, India will experience geopolitical tailwinds. Superpower rivalry gives India an opportunity to be seen as a bulwark against China. India’s participation in Quad, the launch of the new Indo-Pacific Economic Framework for Prosperity, and strengthening our technology partnership with the US can yield big benefits.

The fear of China will continue to mount in the US and exploiting that space will be critical for India. Given the state of other emerging economies such as Russia, Brazil, Turkey and South Africa, India’s strong growth will see indices like Morgan Stanley Capital International rerate their emerging market portfolios and increase their exposure to India and Southeast Asia.

This is an important economic period for India. The country must navigate the current complexity well and take advantage of the geopolitical tailwinds. The medium-term augurs favourably for India’s growth prospects and even its place in the world. We must all work together to seize the opportunity.

Janmejaya Sinha, is chairman, BCG India

The views expressed are personal

Catch every big hit, every wicket with Crickit, a one stop destination for Live Scores, Match Stats, Infographics & much more. Explore now!

See more

Get Current Updates on India News, Elections 2024, Lok sabha election 2024 voting live , Karnataka election 2024 live in Bengaluru , Election 2024 Date along with Latest News and Top Headlines from India and around the world.

Continue reading with HT Premium Subscription

Daily E Paper I Premium Articles I Brunch E Magazine I Daily Infographics
freemium
SHARE THIS ARTICLE ON
SHARE
Story Saved
Live Score
OPEN APP
Saved Articles
Following
My Reads
Sign out
New Delhi 0C
Sunday, July 14, 2024
Start 14 Days Free Trial Subscribe Now
Follow Us On