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JULY 24,2017

Taming inflationary expectations

  • The official inflation rate dipped to 1.5% last month, the lowest in almost two decades. Inflation is a politically more sensitive challenge than joblessness for the simple reason that it affects everyone, whether you have a job or not.
  • There have been very few instances of such persistent, multi-year, high inflationary episodes in our history. The credit for this goes to the vigilance of the political system and also to effective monetary management. Inflation is after all a monetary phenomenon — more money chasing fewer goods. So, controlling money supply is part of the strategy for controlling inflation.

Food prices as indicator

  • Inflation is also an indicator of whether there is an excess demand or supply of goods.
    • The recent drop in the inflation rate has been caused by a steep fall in the prices of vegetables (-17%) and pulses (- 22%). Conversely, and rather ironically, unseasonal rains in the north have destroyed a large part of the tomato crop causing prices to skyrocket.
  • Food prices are a big component in the determinant of the overall inflation rate based on the consumer price index basket.
    • Inflation control thus involves a combination of monetary management along with measures to increase supply of goods (in the medium term) as also anti-hoarding measures or the release of stocks from government warehouses.
  • The new paradigm, called the “flexible inflation targeting” framework, aims for a numerical target given by the government.
    • The main tool to achieve it is by setting the benchmark interest rate. This decision is now taken by the six-member monetary policy committee (MPC), chaired by the Governor.
  • The current inflation target is 4% plus or minus 2%. The MPC is deemed to have failed if for three consecutive quarters the inflation rate falls outside the band.

        Low inflation pointer

  • The benchmark rate (called the repo rate, or the rate at which the RBI gives money to banks) at 6.25% may be too high. Interest rates are the “price” of money, so if they are too high, money becomes scarce. If it is lowered, then there will be more money in circulation, more loans given out.
  • But low inflation is also because of a steep fall in prices of fruits, vegetables and pulses, none of which was caused by high interest rates. These steep falls are highly seasonal. We have also benefited from low and stable crude oil prices, which are a crucial determinant of transport and energy costs.

MPC Expectations

  • India needs much lower rates for higher GDP growth.
    •  High rates are crippling borrowers who try to come out of near-bankruptcy and are preventing a restructuring of stressed bank loans. India’s real interest rates, i.e. net of inflation, are quite high even compared to other developing countries
  • The short run impact of the Goods and Services Tax (GST) is bound to be inflationary. That’s because a bulk of India’s GDP is in services whose tax rate has moved from 15% to 18%.
    • Besides, while sellers wait for their refund, i.e. input tax credit under the GST, their cost of capital locked up might go up
  • Besides the GST, there is the impact of the award of the Seventh Pay Commission to government employees.
    • This effect will cascade to public sector organisations and State-level employees as well, and put pressure on prices.
  • The loan waivers announced in some States which can cause fiscal stress. High deficit spending is not compatible with lower interest rates.
  • A fourth factor is the uptick in commodity prices worldwide as metals and food prices are looking up
  • The last, and probably the most important, factor weighing on the MPC’s mind would be inflation expectations.
    •  Expectations are irrational, but they do affect behaviour.

The boycott ban

  • Maharashtra’s new law prohibiting the social boycott of individuals, families or any community by informal village councils is a step in the right direction, given the pervasive nature of the problem.
  • It targets the pernicious practice of informal caste panchayats or dominant sections using ostracism as a means of enforcing social conformity.
  • The Maharashtra Protection of People from Social Boycott (Prevention, Prohibition and Redressal) Act, 2016, may serve as a template for similar legislation in other States.
  • The Act lists over a dozen types of actions that may amount to ‘social boycott’, which has been made a criminal offence punishable with imprisonment up to three years or a fine of Rs. 1 lakh or both.
  • The practices it prohibits range from preventing the performance of a social or religious custom, denial of the right to perform funerals or marriages, cutting off someone’s social or commercial ties to preventing access to educational or medical institutions or community halls and public facilities, or any form of social ostracism on any ground.
  • This is not the first law of its type. Bombay enacted a law against excommunication in 1949, but it was struck down by the Supreme Court in 1962 after the Dawoodi Bohra community successfully argued that it violated the community’s constitutional right to manage its own religious affairs.
  • Article 17 of the Constitution and the Protection of Civil Rights Act outlaw untouchability in all its forms, but these are legal protections intended for the Scheduled Castes.
  • In reality, members of various castes and communities also require such protection from informal village councils and gatherings of elders who draw on their own notions of conformity, community discipline, morality and social mores to issue diktats to the village or the community to cut off ties with supposedly offending persons and families.