Contradictions in policy-making

Consistency in policy-making seems to be a casualty of the government’s ideological drive to “deepen reform” even while economic circumstances demand a completely different policy track. Nowhere is this more visible than in the response to persisting inflation. The government itself has decided that the inflation problem, earlier focused on food but now more generalised, would take care of itself once the monsoon progresses further. More important to it is the need to “exit” from the stimulus resorted to in the wake of the recession, even if that involves besides expenditure reduction an increase in administered prices. So in what it presents as a brave, “anti-populist” move it has decided to resort to steep hikes in the prices of petrol, diesel, kerosene and LPG and begin the transition to a “free pricing’ regime for petrol (initially) and diesel (subsequently). With some of these commodities being universal intermediates that enter into the costs of production of most commodities and others being part of the common person’s consumption basket, this move is bound to intensify and prolong the already lengthy inflationary episode the country has been experiencing. And the burden of such inflation would fall more severely on the large mass of poor that populate this country. Yet, the Prime minister has openly endorsed the petrol products price hike and the dismantling of administered pricing in this area, indicating where the inspiration for the policy comes from.

What is surprising is that despite statements to the contrary by Finance Ministry mandarins, the government, or at least one important arm of government, does not believe that inflation would just go away. The Reserve Bank of India has decided to step in and do something to curb inflation with policy. Thus, well in advance of its regular monetary policy review due at the end of July, the Reserve Bank of India has decided to hike key interest rates. It has raised both the repo rate and reverse repo rates by a quarter of a percentage point each to 5.5 and 4 per cent respectively. Since this would raise the cost at which banks can access liquidity the move is likely to impart upward pressure on key rates in the system.

Explaining the motivation for its surprise action, the RBI attributes it to the need to “contain inflation and anchor inflationary expectations going forward”. In fact, the central bank expects non-food and fuel price increases to add significantly to inflation in the coming months. The likelihood is that the fuel price hike and the delayed monsoon would push inflation beyond the RBI’s expectations, resulting in further rate increases in the coming weeks and months. In practice, therefore, the RBI is paying attention to combating inflation while the government is working to intensify it. The inconsistency is obvious. But this is not the only instance of inconsistency. If the RBI’s rate increases are to work to contain inflation they would do so by curbing demand including the speculative demand for food articles. This would adversely impact growth, especially since the government is committed to cutting back on its fiscal deficit. So clearly, in the desperate rush to implement price decontrol as part of economic reform, the government is willing to sacrifice growth even while contributing to inflation. The RBI is less blatant on this count as well and has decided to sustain easy liquidity conditions even while hiking rates, introducing another element of inconsistency into the policy environment.

In sum, those who are willing to borrow at higher interest rates would be able to access credit. Such borrowers are unlikely to be borrowers looking for finance for productive investment or those wanting to borrow to sustain consumption. High cost borrowers are most likely to be speculators who expect to recover the marginal cost increase with higher returns.

So the strategy of limiting inflation being adopted by the RBI is being diluted, to support a feeble effort to sustain the recovery that the economy has experienced.

These moves affecting growth and inflation in contradictory ways have adverse distributive implications. Inflation hurts the poor by eroding real incomes, especially when it affects food articles and essential commodities entering the consumption basket of these sections.

On the other hand, higher interest rates benefit financial investors and do not harm the well to do looking to borrow, since the latter can bear the increased cost so long as they have access to the liquidity they need. This obviously means that the internally inconsistent policy stance of the government and the central bank is also regressive in terms of its likely outcomes. The government is not just unconcerned about inflation or growth, it seems to be indifferent to the distributive implications of its policies. In a country overwhelmed by poverty and deprivation this is not just apathetic but plain callous. Strangely, even the financial markets do not seem to approve.

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Printable version | Jan 20, 2022 3:19:12 PM |

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