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LATEST NEWS UPDATES | Should the government loosen its purse strings? -Prashanth Perumal

Should the government loosen its purse strings? -Prashanth Perumal

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published Published on Jan 21, 2022   modified Modified on Jan 21, 2022

-The Hindu

As inflation is driven by supply-side factors, tax policy can be used to cushion its impact

With the Union Budget 10 days away, many economic observers are now focused on what support the Centre can offer the economy, which is still struggling to recover from the pandemic. Some analysts believe that the government must keep its spending in check to prevent price rise from getting out of control. Retail inflation is hovering close to 6%, while the wholesale inflation rate is in double digits. Other analysts, however, believe that the current rise in prices is a temporary phenomenon, and that the government must ignore the fiscal deficit and ramp up spending to support the ailing economy. In a conversation moderated by Prashanth Perumal J., N.R. Bhanumurthy and Himanshu discuss the way forward. Edited excerpts:

* What is your view on the current trend in price inflation?

N.R. Bhanumurthy: First of all, when it comes to retail inflation, the latest reading says it is somewhere close to 5.6%. The Reserve Bank of India (RBI) has already predicted that it will remain below 6% by the end of March. However, many of us believe there are some upside risks when it comes to inflation and inflation expectations. This is for a couple of reasons. One, international oil prices have gone up to $87 per barrel this week. We also see that inflation pressure is building up across the world, especially in countries where there was a large fiscal stimulus. So, there could be the risk of transmission of international inflation to the domestic economy. But at the same time, one needs to really understand what drives this inflation. At least in the Indian context, supply-side constraints play a major role and this needs a different policy prescription. And I’m very sure that the RBI has many instruments to contain this inflation pressure. For the past three quarters, the RBI has been hitting bull’s eye when it comes to inflation forecasts, so I think when it says that retail inflation will be less than 6%, it’s likely to come true. With regard to Wholesale Price Index (WPI), I’ve been a little wary of this reading. You cannot have wholesale market prices and retail market prices diverging for a very long time. We generally expect the transmission between the wholesale market and the retail market to not be more than one or two months. But what we see now is a very prolonged divergence. We need to look at a little more in detail in terms of the coverage and commodities and all those things. We need to focus more on Consumer Price Index (CPI) and less on wholesale prices.

Himanshu: We have to be very cautious in not just looking at inflation numbers in aggregate, but also what is driving inflation. I think that most of the inflation is basically driven by supply. Also, it not driven as much by domestic factors as it is by international factors. But domestic factors have added to the problem. The most obvious factor is that taxes on petroleum goods and services have increased. So, domestic factors have contributed to inflation, but the inflation is predominantly driven by the supply side. But I would also be a bit hesitant in saying that there is only little that can be done using fiscal policy.

Second, I think the gap between WPI and CPI is quite a big one and it has been so for a long time. Some of the inflation in wholesale prices will be passed on to consumer prices, so inflation is a cause of concern not just for fiscal policy or monetary policy, but also for the overall health of the economy because inflation is going to impinge on the basic economics of households.

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The Hindu, 21 January, 2022, https://www.thehindu.com/opinion/op-ed/should-the-government-loosen-its-purse-strings/article38299823.ece?homepage=true


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