Just as the country was basking in the glow of the 13.5 per cent GDP growth posted in the first quarter of this fiscal, came the depressing news early this week of rising retail inflation and falling industrial growth. The retail inflation in August shot up to 7 per cent after moderating to 6.7 per cent in July driven by a price spike in cereals and vegetables. Food inflation in August surged by almost a percentage point to 7.62 per cent in August from 6.69 per cent in July.

This was the eighth consecutive month where retail inflation was above the RBI’s upper tolerance band of 6 per cent. Going ahead food inflation is likely to worsen as the impact of the patchy monsoon plays out on agriculture production.

Buffer stock worries

More worryingly for the government, the foodgrain buffer stocks with the Food Corporation of India are also depleting fast. The stocks of wheat, rice, and unmilled paddy dropped by a massive 33.5 per cent in September, year-on-year. Wheat stocks have plummeted by 52.1 per cent, as output was hit by the heat wave in March-April.

The government was also quick to ban export of broken non-basmati and imposed a 20 per cent export duty on non-basmati paddy and rice. This was done to ensure food supply for domestic consumption. Also there were also some price factors at play, the global rice prices are ruling below the government’s minimum support price to farmers.

The export curbs on rice were largely welcomed, which is in contrast to the furore the wheat export ban created a few months ago. The government may have to extend the PM Garib Kalyan Anna Yojana, which provides free rations, beyond the current September 30 deadline.

Ironically, the worrying news on the price front comes just days after Finance Minister Nirmala Sitharaman, at the India Ideas Summit, said that inflation was manageable and issues such as job creation and equitable distribution of wealth had now come to the fore.

That the focus back on inflation shows how volatile the situation is and also how “sticky” inflation has become. But the Finance Ministry for now has put on a brave face and said the recent spurt in prices was “moderate”. It said the steps taken by the government — export ban on some varieties of rice and rationalisation of import tariffs of pulses and edible — will help bring prices down in the next few weeks.

RBI’s dilemma

Now given the recent spurt in inflation, the Reserve Bank is likely to hike policy rates in the MPC’s meeting later this month. What the RBI would be looking at is not only food inflation but core inflation (which excludes food and energy), which is at an elevated level. Also, rural inflation has been consistently higher than urban inflation.

But what will be the quantum of hike? A 50-basis point hike seems to be the consensus view. Economists are not surprisingly are divided on the quantum of hike. Some argue for smaller hikes going ahead given the growth imperatives.

Rate hikes typically play out over a lag, which means they might end up crimping credit just when growth is set to pick up.

But this also brings us to a more important question. How effective are the standard monetary policy tools in fighting price rises? Not very, going by recent experience. This is hardly surprising as inflation in India is more of a supply-side issue and not as much a monetary phenomenon. So, demand compression is unlikely to work in India where economic activity post-lockdown is picking up.

Also there are a myriad set of factors driving inflation – oil price spike (due to the Russia-Ukraine war), patchy monsoon impacting agri output, supply chain glitches to name a few. Rate hikes, the standard monetary policy tool, may not work in isolation and may have to be dovetailed into fiscal policy.

FM’s take

In this context the Finance Minister’s recent observations on fiscal and monetary policy working in tandem to fight inflation gain significance. Sitharaman at an event organised by the think-tank Indian Council for Research on International Economic Relations said RBI alone cannot be left to combat inflation. She said the RBI will have to find a way to “synchronise” monetary policy tools with other central banks.

She also interestingly suggested that the Centre and States must join hands to bring down prices. She urged States to cut taxes and duties at their end — the obvious candidate being petro products.

Though there may be some merit in this argument there are two reasons why the Finance Minister’s suggestion is unlikely to find traction among States especially those ruled by Opposition parties. One, given the parlous condition of State finances, States can hardly afford to cut duties and taxes as they are desperate to raise revenue to fund their expenditure.

Political wrangling

Two, apart from the fiscal pressures, there are some serious political factors at play. Given the series of State elections lined up from now and the 2024 elections, one can hardly expect parties such as the Congress, AAP, Trinamool Congress and TRS to join hands with their bitter rival BJP to fight inflation.

For the Finance Minister’s suggestion to work operationally political parties must make an honest attempt to set their differences aside and it’s impossible to see that happening in the current political milieu.

The more important question is once the State elections’ campaign kicks off, will political parties start indulging in another round of “freebie” promises? If so, how will that impact the already precarious State finances and ultimately inflation? These are some of the difficult questions the Indian polity has to confront in the coming month