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Mainstream, VOL LX No 29, New Delhi, July 9, 2022

Balancing Growth and Inflation | Atul Sharma, Shyam Sunder

Friday 8 July 2022


by Atul Sharma, Shyam Sunder *

India’s economy recorded growth of 8.7 % in 2021-22. Several agencies such as OECD, Moody’s and IMF slashed India’s growth for 2022-23. Of late The World Bank lowered for the second time GDP growth forecast for 2022-23 to 7.5% from 8% in April and from 8.7% in January, 2022. Even the RBI has cut its growth forecast to 7.2%. The edging down the forecast has been attributed to “headwinds from rising inflation, supply chain disruptions, geopolitical tensions offsetting buoyancy in the recovery of services consumption from the pandemic”.

Inflation based on consumer price index (CPI) which is being driven by food, fuel and fertilizer climbed eight- year high at 7.79 % in April 2022. Following excise duty cut on petrol and diesel, export curb on wheat and sugar and enhanced fertilizer subsidy, it has cooled off to 7.04% in May. It is still much higher than 6.3% in May 2021 and far above the outer bound of RBI’s target range of 2-6%. India’s wholesale inflation has risen to 15.88 % in May, the highest since September 1991. It indicates that the retail inflation may stay elevated in the coming months. Crude prices have risen $10 a barrel since the GoI’s excise cut. Inflation will accelerate further if oil companies pass on this rise to consumers. Crude price and rupee depreciation are likely to keep the retail inflation elevated for a while.

To curb inflation, the RBI has hiked interest rates twice in two months, the latest being in June and it was raised from 5.7% to 6.7% for 2022-23. It expects inflation to be in the region of 7.5%, till October-December quarter by which the summer harvest is expected to cool off the inflation to 6.2%. This would force the RBI to further tighten the money market.

On 15th June, the US Federal Reserve (Fed) has also hiked its policy interest rate by 0.75 per cent, highest since 1994 -to contain its persistently rising inflation that has peaked at 8.6% in May. It has taken the central rate to 1.625% (official range of 1.5 -1.75%). The Fed has indicated that it would further raise policy rate by at least 50 basis point in its next meeting on July 27.

The Fed‘s rate hike has several implications for India. First, the Fed action would force the RBI to raise policy rate to maintain the rate differential between dollar-rupee currencies. This would have impact on local bond yields leading to the benchmark 10-year paper rising above 8% for the first time since October 2018. With rising bond price, borrowing costs will be high. That would impact company results. Second, the Fed action might spur portfolio investment outflows necessitating policy actions to reverse capital outflows. Third, India being its second largest trading partner after China, the US export recession resulting from the rate hike would depreciate rupee. That would benefit exporters. However, The World Bank has slashed global growth to 2.9% from 5.7% in 2021 and from its January estimate of 4.1%. That would dampen, exporters’ possible gain. With the rupee being under pressure, trade deficit would widen since weak rupee might boost export but enlarge import bill of crude more. Fourth, US trade recession might adversely affect India’s service exports. With that, foreign direct investment into information technology might shrink.

Taking cognizance of inflationary impact of fuel prices, the GoI on May 21 has cut the Central Excise duty on petrol by ₹8 and on diesel by ₹ 6 per litre. This is expected to reduce the petrol price by ₹ 9.5 and diesel by ₹ 7 per litre. This measure would cause revenue loss to the tune of ₹ 1 lakh crore per year. Further, in view of rising fertilizer prices globally, the GoI has announced fertilizer subsidy of ₹1.10 lakh crore as price protection for famers over the 2022-23 budget
provision of ₹1.05 lakh crore.

These two fiscal measures to tame inflation together with the proposed recruitment of 10 lakhs personnel by the GoI would build pressure on the fiscal deficit at 6.4% as budgeted for 2022-23. Incidentally, as reported by the 7th Pay Commission, 88.72 % of the Central government personnel as on January 1, 2014 are categorised under Group-C while only the remaining 11.28% under the Groups A and B. It indicates that the bulk of 10 lakh new recruits would be under Group C even with growing use of new technology. This would swell government’s salary budget but add precious little to governance. Unless revenue growth is higher than estimated, the government would have to compress capital expenditure. For, high committed expenditure - interest expenditure itself claims 43% of revenue receipts-leaves little elbow room for revenue expenditure compression. The fiscal deficit would edge up if expenditure compression or revenue expansion is not feasible. High fiscal deficit might adversely affect global rating which in turn affects external capital flows that supplement domestic investment.

High interest rate discourages investment. Worse, the Fed’s interest hike might lead to portfolio investment outflows and lower FDI inflows. However, even without these impediments, producers have not pushed up investment significantly despite various incentives. Because, with slack in consumption growth, manufacturing companies have witnessed a considerable excess capacity. As per RBI’s quarterly Order Books, Inventories, and Capacity Utilisation Survey (OBICUS), although capacity utilization of sampled IIP manufacturing companies improved from 68.3% during quarter 2 : July-September to 72.3 during quarter 3: October-December 2021, it still leaves more than a quarter (27.7%) excess capacity.

High inflation retards growth. So does consumption. Worse still, inflation hurts everyone but hurts the poorest the most. Private final consumption accounting for 56.9% of GDP which is a major growth driver increased only by 1.43% between 2019-20 and 2021-22. Worse, per capita final consumption at 2011-12 prices has slumped to ₹61215 in 2021-22 from ₹61594 in 2019-20. Proposed bulk recruitment would boost consumption even if overturn much touted ‘minimum government and maximum governance’. No doubt, job creation lies at the core.

The way forward would be to find the factors that have made 2783 out of 12584 active foreign companies with registered offices or subsidiaries in India closed or downsized their operations in the country between 2014 and 2021(Commerce and Industry Minister informed Parliament) despite various incentives including those under ‘Make in India” and improved ease of doing business and address them. Such factors might have also discouraged domestic investment. Redressal of those impediments might mitigate to an extent the adverse impact of inflation taming measures on growth.

* (Authors: Atul Sarma (sarmaatul[at] is Former Head and Professor of Economics, Indian Statistical Institute, Delhi Centre and Shyam Sunder ([at] is working with an Indian Corporate. Views are personal.)

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