Saturday, March 20, 2021

Rising Inflation Poses Risk to the Recovery in the Indian Economy

For the last many months, inflation in the Indian economy is rising. Both the retail inflation as well as the core inflation has increased to 5.03 percent and 5.7 percent respectively in the month of February 2021 in the economy in comparison to the month of January 2021. During the same period, the Index for Industrial Production (IIP) has contracted by 1.6 percent (Mishra, 2021). This has happened when the economic activities in almost every sector of the economy is expanding (Upadhyay, 2021).

Technically this increase in the inflation can partly be attributed to the small base belonging to the earlier month but on overall, it is largely due to the cost push pressures building up in the economy. Most importantly, the inflation is not expected to moderate significantly in the short term besides the base effect until and unless the government decides to cut the taxes on the petroleum products. A major reason for the accelerating inflation in the economy is due to the increasing prices of petrol and diesel. In the last one month, the prices of petrol and diesel have increased by 20.6 percent and 22.5 percent respectively (Kaul, 2021). As a result of the increasing price of petroleum products, the demand for the petroleum products has contracted consecutively for two months in a row since January 2021 (Pathak, 2021).

A major reason for the increase in the prices of petrol and diesel in the Indian economy is very high taxes extracted on these products by the central and state governments along with the increasing crude oil prices in the international market due to the decreased supply of crude oil by the oil producing countries. The high taxes on the petroleum products are pushing the costs of these products upwardly which is accelerating the cost of production in the economy. The accelerating cost push pressures are directly and indirectly pushing the inflation upwardly. Even the RBI through its monetary policy meeting in the month of February 2021 has already cautioned about it but did not change the key policy rates considering the need to support the economy for continued recovery and growth in the economy. RBI is continuing its accommodative monetary policy stance (RBI, 2021a) because any significant increase in the rate of interest will have a negative impact on the capital expenditure and investment in the economy which may result in slowing down the recovery process; a risk which Indian economy at this point of time cannot afford. RBI in its bulletin has already raised its concern about the rising yield on bonds which may undermine the recovery and unsettle the financial market which may also result in capital outflow (RBI, 2021b). These peculiar situations leave RBI with very limited options to tame the inflation in the economy.

The rising inflation can reverse a large part of the economic gains due to accelerating economic recovery made in the last one quarter. The higher proportion of petroleum products in the expenditure baskets of the consumers will leave them with less disposable income to spend on the other sectors of the economy which will have a negative impact on the overall aggregate demands in these sectors. The overall falling demands in the economy will hurt the business and economic sentiments and environment. So it is the time for the central government to take cognizance of the situation and action against the rising inflation in the economy, else the economic activities that have gained momentum and the positivity in the business and economic environment will start eroding.

It must be noted by the central government that if the inflation continues to elevate in coming months and breaches the upper band of the targeted consumer inflation, it will hurt every sector of the economy and the demand. The fall in the demand in the economy will affect revenues of most of the businesses particularly the micro, small and medium enterprises (MSMEs) adversely. This fall in revenues will increase the risk of survival for most of these MSMEs and might lead to increased numbers of insolvencies and bankruptcies in the economy. Rise in the insolvencies and bankruptcies will worsen the non-performing assets (NPA) conditions in the economy gravitating and complicating the banking and financial sector crisis further.

In such a peculiar situation only the central government along with the state governments can provide relief to the economy else increasing inflation will extend the economic recovery period to create more problems for the economy. The governments should at this point of time put aside their greed to collect more revenues from the petroleum products to finance the increasing deficit and put a dynamic mechanism to check the rising prices of the petroleum products. Rather they should focus on diversifying and collecting more revenues from other sectors of the economy by increasing the economic activities as further increase in the inflation would be a constraint for the economy as a whole.

Bibliography:-

  • Kaul, V. (2021, March 13). Rising retail inflation, a big headache for govt, RBI and you. Retrieved from Mint: https://www.livemint.com/opinion/columns/rising-retail-inflation-a-big-headache-for-govt-rbi-and-you-11615636580390.html 
  • Mishra, A. (2021, March 13). Factory output contracts, retail inflation jumps. Retrieved from Mint: https://www.livemint.com/news/india/india-iip-contracts-1-6-in-jan-cpi-accelerates-to-5-03-in-feb-11615551064286.html 
  • Pathak, K. (2021, March 12). India's oil demand falls second month in a row. Retrieved from Mint: https://www.livemint.com/news/india/indias-oil-demand-falls-second-month-in-a-row-11615558985608.html 
  • RBI. (2021a, February 5). Monetary Policy Statement February 3-5, 2021. Retrieved from RBI: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51077 
  • RBI. (2021b, March 19). RBI Bulletin - March 2021. Retrieved from RBI: https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51299 
  • Upadhyay, R. K. (2021, February 26). Indian Economy on the Path of Expansion. Retrieved from The Deliberation: https://www.deliberation.in/2021/02/indian-economy-on-path-of-expansion.html
- Rajeev Kumar Upadhyay

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