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India’s Soaring Inflation Is an ‘Invisible Tax’ On the Poor

Inflation is an added ‘tax’ to the price consumers pay for everything. It's just not officially levied.

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Opinion
8 min read
India’s Soaring Inflation Is an ‘Invisible Tax’ On the Poor
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India’s inflation numbers continue to worry. Retail inflation, as measured by the Consumer Price Index (CPI) – measuring from the basket of what consumers purchase/consume most – surged to 7.79 per cent in the month of April, according to government data released on Thursday. Inflation based on CPI was 6.95 per cent in March this year and 4.23 per cent in April 2021. Inflation in the food basket rose to 8.38 per cent in April from 7.68 per cent in the preceding month and 1.96 per cent in the year-ago month.

The Reserve Bank of India (RBI) has been mandated by the government to ensure that inflation remains at 4 per cent with a margin of 2 per cent on either side.

The current trend of rising retail and producer-price inflation, something seen from mid-2021, was – or has – hardly been part of any temporal rise in prices, as many policymakers and government analysts had earlier argued.

As this author argued in June 2021, the understanding of inflationary expectations during a pandemic (and given the inherent limitations in diagnosing the problem) can spell trouble over a medium- to long-term period not just for industrialised (or ‘developed’) nations like the US but also for low-income (‘developing’) nations like India. I also tried hard to convince NITI Aayog’s Amitabh Kant in a televised interaction, but in vain.

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Can India Even Diagnose the Problem Correctly?

The current issue of price rise may surely be complex, but it’s not complicated. It requires a micro-lens of seeing data with evidence, which has macro-implications. What we see in terms of price-rise at a retail and/or wholesale level is a mixed effect of both supply and demand-side factors.

After weeks of a lockdown, if people want to get a haircut at a salon, for example, its price would depend on how many salon owners have their shops open and how many hair-dressers are back at work. These factors do not work in tandem. It may take time for salon owners to open up while ensuring that COVID protocols are in place, so that consumers feel safe. They would operate on low capacity (taking fewer appointments), and most hairstylists may be reluctant to work or may demand higher wages for their risk of exposure to infection. These factors could push up the general price of a haircut, or other salon services.

Similarly, in an informal space, if a chaiwaala (tea vendor) operating in Delhi sees a surge in demand for tea after a lockdown, he would immediately need a greater quantity of milk from his regular distributor. If the source of this milk happens to be a dairy operation in a state that still has COVID restrictions in place, milk supplies could be disrupted or delayed. In such a scenario, the price of tea would go up.

Interpreting such micro-level observations, I had forecasted a rise in CPI back in May 2021, which is now materialising. An interplay of localised factors has coalesced with a high degree of uncertainty around the lives and livelihoods of various economic agents across India, and this is likely to keep inflation high.

It is extremely hard to take a formulaic approach for addressing such a rise in inflationary expectations. Monetary policy may be less effective.

How COVID Battered Supply Chains

Globally, COVID-19 did induce restrictions on the mobility of goods and services, which affected supplies of essential intermediate goods across all major trading zones, thus delaying the disbursement of finished goods and future contracts, including for transit points like China, which has struggled to contain the pandemic in heavy trading route cities, such as Shanghai.

The wide impact of the Omicron variant in East Asia has left one of the most trade-intensive regions in the world struggling from January-February of this year (when India’s recovery was smoothening), while adversely impacting the region’s linkages with the rest of the world.

The Russia-Ukraine war has only added to pre-existing anxieties by pushing fuel prices up across the globe, making importers of crude oil incur a higher expense or look for alternative exporters in order to get a better deal. India has purposely sought to buy ‘cheaper’ Russian oil despite its projected ‘neutral’ position in supporting or condemning the war.

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Inflation Is an Added Tax, It's Just Not Official

In the short term, everyone loses from a sustained price rise. It isn’t easy for producers to push supplies, given they have a fixed supply chain; making any adjustments to scale up production isn’t easy. For consumers, inflation is an added ‘tax’ to the price they pay for everything, from edible oil to onions to milk – a tax that is just not officially levied by the government.

In India’s deeply stratified society, low-income households struggle even more from ‘inflation tax’. One must know that India’s tax system is already regressive in its structural composition, ie, it depends on generating a larger share of income from indirect taxes (like GST, VAT) than direct taxes (income, wealth tax). In the case of revenue dependence on indirectly levied taxes, the incidence (or burden) of tax is the same on all irrespective of how much one earns, ie, the richest will pay the same tax for 1 kg of onion as the poor. In short, poorer households suffer worse, and the ‘inflation tax’ adds to their misery.

Before COVID hit Indian economy, aggregate demand was already weak, wages were low, unemployment was high, and production and investment capacity were teetering. Now, ‘inflation tax’ will further delay any attempt to coherently design a path towards a sustained, inclusive, economic recovery.

The RBI, India’s central bank, and perhaps the only public institution with a designated mandate to ‘target inflation’, was caught napping during this time.

In some ways, one can attribute the current (inflation) crisis directly to the RBI, which clearly failed over the past year to use monetary policy to check inflation despite repeated warnings and crisis indicators. No statements or remarks made by either the governor or his team in previous quarterly monetary policy review announcements were taken seriously, and inflation was dismissed as a ‘temporary’ problem.

RBI's Recent Rate Hike Is a Desperate Measure

The recent ad-hoc rate hike can now only be seen as a ‘desperate’ measure, maybe at a time when the crisis seems to have already hit the roof. The question is: is the RBI’s move to hike the rate of interest and increase the cost of borrowing to reduce excess liquidity in the economy enough? Can monetary policy alone play a role in taming the ‘inflation tax’?

This is a vital question and one that I raised in a column last June, where I argued about the limited effectiveness of monetary policy (working in isolation) in containing a kind of inflationary trend that is peculiarly defined/caused in a pandemic-hit economy.

A brief background context is needed here. ‘Excess liquidity’ was created in the global economy during the pandemic, especially in developed countries such as the US and much of Europe, where governments spent trillions to keep consumer demand high and prevent any labour market disruptions (because of shutdowns) from adversely impacting the wheel of the production-economy. That was the right thing to do at the time.

The situation in the US now is such that given high consumer demand, there are ‘supply constraints’ (plus the high fuel prices due to the Russia-Ukraine war) that have pushed overall retail prices up. Not just in the US, this trend has driven ‘retail’ prices of goods and services globally, and in India, too.

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A Double Whammy for People in India

However, there is a caveat to the Indian scenario that merits a separate mention. Our own government during the pandemic focused mostly on enhancing some subsidies, increasing foodgrain delivery to the poor, and providing some liquidity support through government-backed credit guarantees to affected MSMEs for a short temporal period.

It didn’t spend excessively (like other nations) in terms of direct fiscal transfers to the poor or other low-income groups to either drive or keep ‘consumer demand’ high.

Most of the government spending during COVID, and as announced in the recent Union Budget, too, was principally guided towards supply-side measures (hoping to attract capital investment), while completely ignoring the brewing crisis on the ‘demand side’.

And so, with the ‘inflation tax’ raising all prices now, consumers and producers face a double whammy. Low-income groups face the wrath. With a lack of better employment prospects, already low wages, and high indebtedness, one can only imagine to what extent a higher ‘inflation tax’ will damage overall consumer sentiments across India in the weeks to come.

The damaging impact of an inflation tax, better understood and studied in the urban landscape, is likely to be far worse in rural India, where retail inflation has been twice as high, and the state of indebtedness, low incomes, lack of jobs is far more intensified.

Further, had the food price rise translated to increasing the incomes of farmers, one could have seen a rising motivation for farmers to produce more or save more. However, despite food inflation, existing distortions in the price-distribution network across India’s middlemen-laden farming network and the ‘urban price bias’ (where 1 kg price of onion sold in the urban market is not the price that the farmer gets for producing that same 1 kg) makes the farmer and the rural economy’s condition more precarious.

Can the RBI and the Government Do Now?

What can the government do in the short term to address the woes stemming from the ‘inflation tax’?

First, let RBI do everything it can in its mandated role to solely focus on ‘inflation targeting’ and suck excess liquidity out of the economy. As C Rangarajan recently argued:

“Inflation in India cannot be described just as ‘cost-push’. Abundance of liquidity has been an important factor (too). If we want to control inflation, action on liquidity is very much needed with a concomitant rise in the interest rate on deposits and loans”.

This may require some time through a tough monetary policy stance, which may be counterproductive to the government’s own efforts towards capital investment-centred growth, as a higher cost of borrowing will make credit more expensive.

Second, use instruments of fiscal policy to make a series of graded direct transfers (especially to the bottom of the income-consumption pyramid) to push for higher demand amongst the lower-income groups, especially in the rural economy.

A monolithic, macro approach to address a temporal rise in inflation, or an effort to fix supply disruptions solely through a monetary policy toolkit, will achieve little. It could even drive other aggregates, such as consumption and private investment demand, towards a deeper recession.

Govt Needs to Put Differences Aside

What is needed is a sustained, fiscal spending-backed income push in the short run to maintain a reasonable space for consumer demand in the rural economy. The Union government will need to cooperate with wtates on this – and this may not be easy given how badly the Centre-state dynamic is rigged currently.

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The first prescriptive point here requires the Modi government to respect the RBI’s decision-making power as a public institution, while letting it perform independently and with clarity.

For the second point, the government needs to acknowledge its wrong and self-correct its fiscal trajectory for FY2022-23 by facilitating more direct transfers to lower-income groups. One short-term step here could be to announce and disburse higher allocations for PM-KISAN and MGNREGA, and launch a pilot urban version of MGNREGA to provide farmers and low-income workers with more ‘spending power’ at a time when regressive taxation combined with the invisible inflation tax is wrecking their household budgets.

(Deepanshu Mohan is Associate Professor and Director, Centre for New Economics Studies, Jindal School of Liberal Arts and Humanities, OP Jindal Global University. He is Visiting Professor of Economics to Department of Economics, Carleton University, Ottawa, Canada. This is an Opinion article and the views expressed are the author's own. The Quint neither endorses nor is responsible for them.)

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