Why IMF doubts Modi government's ability to contain inflation
The International Monetary Fund’s (IMF) latest economic outlook database shows India’s inflation above 5 per cent till the end of 2019-20 and 4.9 per cent by the end of 2021-22.
It is, of course, very difficult for anybody to predict inflation that far ahead, but what it does indicate is that IMF, too, is sceptical about the extent to which the Narendra Modi government will be able to succeed in implementing the inflation target it has set for the Reserve Bank of India (RBI).
It is not just about monetary policy - of maintaining a 4 per cent plus or minus 2 per cent inflation target by the RBI - but more about the feasibility of achieving it, which depends on several other factors, that is making the IMF doubt whether it is doable at all in the time-frame set by the Modi sarkar.
However, the IMF believes India will be able to achieve a growth rate of 8 per cent plus by 2021-22. This again looks like a far-fetched estimate, but what the numbers imply is that India is accelerating in its economic growth.
Whether higher growth implies higher inflation is an important question. Growth is achievable going by the rising trend of investments and savings. It is interesting to note at the same time that despite higher growth, both investments and savings as a percentage of GDP will be lower in 2021-22 compared to 2014-15.
The IMF thinks interest rates will not get back any time soon to the 34 per cent-of-GDP level of 2007-08.
It also believes that volume of both exports and imports is likely to pick up this year and show good momentum thereafter.
The IMF’s main concern about India is the war on food inflation. It is felt that sustainability of the inflation target of 4 per cent under recently adopted flexible inflation-targeting will depend on enhancing food supply, agricultural market-based pricing and reducing pricing distortions.
Fixing supply issues to control price gains must be the major task of the Modi government. That job became harder after back-to-back drought eroded harvests last year which prompted the government to roll out measures to boost rural incomes in its last Budget.
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| IMF's outlook on India's economic growth is more optimistic. (Photo credit: Reuters) |
The IMF thinks that the central bank should stand ready to raise rates if price pressures pick up. It recommends the following measures on the food front:
- Yields in key commodities must improve as accelerating economic growth stokes demand for food.
- India trails other emerging markets with rice yields at a third of China’s and a half of Vietnam’s.
- Farmers have been slow to adopt technology and improved seed varieties in cereal productions.
The government should shift to open market sale of cereal stocks held by the Food Corporation of India, which rose up in recent years, posing the problem of spoilage due to lack of safe storage facilities.
If the government releases more grains in a year of low production and increases reserves during a good year, it would stabilise both consumption and market prices of cereals.
The government’s minimum purchase price is an important impediment to monetary policy transmission and monetary policy management in India.
The government has curbed increase in guaranteed purchase prices ever since Modi took over as PM in 2014 - one of several steps the IMF is saying will help contain inflation in the near-term, until more durable measures are taken.
In the absence of effective and reliable links between policy instruments and aggregate demand in Indian currency, the public may lack confidence that the RBI will be able to deliver on its announced inflation target, making the target more difficult and costly to achieve, said a recent IMF working paper.
On the one hand, the size of the formal financial sector is small in India which is likely to undermine the effects of bank lending rates on aggregate demand, while on the other, the response of the exchange rate to monetary policy shocks is in the right direction though the magnitude is small.
The implication is that the effects of monetary policy on aggregate demand in India are more likely to operate through the trade balance rather than through interest-sensitive components.
The mechanisms of monetary transmission on low-income countries may not be similar to those found to operate on high income ones, the IMF report concludes.
It is very difficult again to predict how RBI's inflation-targeting will play out in the long run for India, keeping in view the implications of macroeconomic factors on aggregate demand and the inflation trends of India.