Why is the Modi government failing to control inflation in India? – Quartz India
There are few more politically sensitive issues in India than inflation or rising prices. With frequent elections at the federal level and the Union government being seen as responsible for economic policy, the ruling parties in India are making great efforts to control prices.
The stubbornly high inflation rates in the last few years of the Congressional-led United Progressive Alliance (UPA) government, following the global economic crash, are often seen as one of the main reasons it has was rejected in 2014.
For most of the past seven years, Prime Minister Narendra Modi’s government has done well on this front. But recent developments should worry the Bharatiya Janata Party (BJP).
Inflation in India is exploding lately
For May 2021, India’s retail inflation rate, measured year-on-year, was 6.3%. Rural inflation (6.48%) was higher than urban inflation (6.04%).
It was above the Reserve Bank of India’s (RBI) upper 6% threshold for inflation, the first time the limit has been exceeded in six months.
The two main factors were a massive surge in the prices of edible oils (30.84%) as well as an increase in fuel prices (11.58%). The price of pulses – an important part of India’s food basket – also rose 9.39%.
The May figures were part of a larger upward trend in inflation in India. Since January 2019, when retail price inflation hit a low of 2.04%, erasing the RBI’s lower 2% threshold, prices have been rising steadily. In October 2020, inflation was 7.61%, its highest level in six and a half years. Even more worrying for the Modi government was that it was fueled by food inflation. The consumer food price index registered an increase of 11.07% year-on-year.
How did Modi control inflation up to this peak?
One of the reasons why high inflation has such an impact is that so far the Modi government has done a remarkable job of managing the rising prices.
It is no coincidence: inflation has been at the heart of Modi’s governance strategy.
In March 2016, the Modi government amended the Reserve Bank of India Act to put in place an inflation targeting regime to be followed by the central bank. The RBI was to conduct a monetary policy (which consists mainly of controlling the money supply via levers such as loan interest rates) which made it possible to limit inflation to 4% with a band of 2 percentage points. In effect, this meant that the job of the central bank was to ensure that inflation would stay between 2% and 6%.
As this document from the National Institute of Public Finances and Policies (pdf) points out, the policy was a success, the Modi government having controlled the volatile inflation of the UPA years: the average inflation rate between October 2016 and March 2020 was 3.93%.
Happy Indian consumers but disgruntled farmers
Like any government policy, low inflation has winners and losers. While consumers have benefited from low food prices as a corollary, farmers – the people who produce and sell food – have been the losers.
To achieve low food prices, the Modi government imposed strict market controls on agricultural products. As economist Abhijeet Banerjee points out, this means that farmers “pay for our inflation target”, as agricultural exports are often banned in order to control inflation.
Agricultural journalist Harish Damodaran gives the example of how an inflation targeting regime ends up “violating all the rules of free trade” in agriculture in order to lower food prices:
“In 2016-2017, the country produced a record 22.95 tonnes of pulses, in addition to imports of 6.61 tonnes. The fact that farmers were ready to harvest a bumper crop had been known since late 2016, when prevailing market rates had already plunged below MSPs. However, storage limits were only removed in May 2017, while import restrictions on arhar, urad and moong, as well as a 50% tariff on peas white, were applied in August-November. The Modi government also released exports of ground pulses in mid-September. But it all went well after the damage was done.
This is of course a politically sensitive point, given that agriculture is by far India’s largest employer.
Critics of the inflation targeting regime also argue that keeping loan interest rates high slows growth. In some cases, critics even attribute the current slowdown in India’s economy to inflation targeting. However, unlike the farmer income point, this is a contested argument and many economists also argue that it has not hurt growth.
Why are Modi’s attempts to control inflation failing now?
Talk to Scroll. InNIPFP member Radhika Pandey identifies four main reasons for the recent rise in inflation. “The most significant are the supply side disruptions due to the Covid-19 lockdown,” she said.
In view of the dislocation of the foreclosure, the manufacturing and supply chains have been affected, resulting in a decrease in products and hence an increase in the prices of products reaching the markets.
In its Quarterly Review of the Economy released on June 25, the Delhi-based think tank National Council of Applied Economic Research pointed out that the pandemic dislocation has meant that core inflation (minus food and fuel) remains high. .
In addition, there is an international dynamic. “There is an asynchronous recovery, with rich countries opening up and restarting their economies, resulting in higher prices for crude and metals,” Pandey explained.
The third is the rise in the prices of edible oils and legumes. “Since India imports both, international prices play a big role and the Indian government’s room for maneuver is limited,” she said.
The fourth is high fuel taxes that drive up oil prices. “The government is not inclined to reduce fuel taxes given its own fragile fiscal situation,” Pandey explained.
Since none of these factors can be addressed using monetary policy, the RBI’s so far successful inflation targeting frameworks are largely ineffective.
Instead, the responsibility lies with the Modi government, which has taken steps to reduce prices. On July 3, he lowered import tariffs on palm oil, the most widely consumed edible oil in India. On the same day, he also imposed stock limits on pulses. An important decision given that it reverses the logic of liberalization of one of the agricultural laws adopted in September 2020 – the 2020 law on essential products (amendment) – which allowed the limitation of stocks only in emergency circumstances. such as war.
Notably, however, there has been no decrease in taxes and duties on petrol and diesel as other fiscal sources for the Union government, such as the tax on gasoline and diesel products and services (GST), have been lackluster.
Political crisis for Modi
Inflation is one of the main factors that led to the fall of the government of Manmohan Singh. An average retail inflation rate of 10.4 percent over the five years of the United Progressive Alliance-2 government led to strong opposition to power in the 2014 Lok Sabha elections.
Modi, after coming to power, learned well from this lesson and worked hard to control inflation.
While this won consumer approval, it also created the dissatisfaction of farmers as low food prices hurt producers. A result of this can be seen in the long protest by farmers in Punjab and Haryana at the Delhi borders. While the immediate cause of the sit-in was the three farm laws passed in 2020 in an attempt to let the free market play a bigger role in agriculture, declining farm incomes have created fertile ground for discontent.
Overall, however, the political impact of inflation targeting has been positive for Modi, with happy consumers voting in government for a second term with a massive term in 2019. To maintain those tailwinds, Modi will need to again reduce rate inflation, even in the face of disruptions like Covid-19.
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