Decoding the economy better
The current situation points to the need for a rethink in the inflation-targeting framework
The headline is that the Reserve Bank of India (RBI) will, by the second quarter of the current fiscal, have failed to meet its inflation objective (retail inflation below 6%). The law requires it to explain its failure in writing to the finance ministry. On Wednesday, the monetary policy committee of RBI raised the policy rate by half a percentage point (as widely expected), left Gross Domestic Product estimates for 2022-23 untouched at 7.2% (unexpectedly), and revised upward its inflation projection for the year to 6.7% (again, as expected). The number disaggregates to 7.5%, 7.4%, 6.2%, and 5.8% over the course of the financial year. It assumes that the average price of India’s crude oil basket will be $105 in the year, and that the southwest monsoon, expected to be normal, ends up being so. There are risks on both fronts, but there is a larger issue.
And that, as one of RBI’s senior-most officials has asked previously, is whether a deeper study is needed into how the pandemic has affected key economic metrics (and the constituents that go into these). That’s only natural — cost and efficiency were the most critical parameters before the pandemic for most businesses; through the pandemic, they have been replaced by safety and continuity. For instance, would global supply chains have ended up as fragile as they have proven to be if companies had not prioritised cost and efficiency over all else? And given the experience of the past two years, which country would prioritise costs over self-reliance? While there are other factors (the Russian invasion of Ukraine is a big one) behind the inflationary surge around the world, at least some of the problem is on account of adjustments necessitated by how countries and companies strategise, plan, and work now. And at least some of it is on account of the climate crisis (the dip in India’s wheat output this year is directly attributable to this).
Apart from raising legitimate questions about the efficacy of monetary measures in fighting inflation (specifically, it can do nothing when the cause is either a war or the climate crisis), the current situation may well be pointing to the need for a rethink in India’s inflation-targeting framework. Is 4plus or minus-2 sacrosanct? What would a 5-plus or minus framework mean? Classical economists may be outraged, but there is a larger question waiting to be answered in inflation data (and not just India’s).