Does the government favor politics over economics?


New Delhi: Is the Modi government prioritizing political gain over much-needed economic prudence, keeping an eye on crucial parliamentary elections to come in Gujarat and Himachal Pradesh this year and more next ?

The answer seems to be yes, based on several key decisions announced over the past week: the Reserve Bank of India’s announcement of a 50 basis point (bp) hike in the repo rate, the extension by the Union government of the Pradhan Mantri Garib Kalyan Anna Yojana (PM-GKAY) free food program for another three months, and the Finance Ministry’s decision to postpone the imposition of a tax on unblended fuel.

All of these decisions, economists say, have the potential to pay significant political dividends, but they could also have commensurate economic costs.

Read also : RBI raises repo rate by 50bps to 5.90%, warns of widening pricing pressures

Ineffective repo rate cuts

While the decision on the repo rate (the rate at which the central bank lends money to commercial banks) is taken by the Monetary Policy Committee (MPC) of the RBI, this is usually done after extensive consultations with the ministry. finances. In addition, three members of the MPC are appointed by the government.

An analysis of the repo rate and retail price inflation over the past decade has shown that there is virtually no correlation between the two. In other words, it does not necessarily mean that a rise in interest rates will be followed by a fall in inflation, or that a fall in interest rates would stimulate inflation.

Chart: Ramandreep Kaur | The footprint

The reason is largely structural, experts say.

“There is going to be a disconnect between the repo rate and the consumer price index (CPI),” Madan Sabnavis, chief economist at Bank of Baroda, told ThePrint.

“This is because of various factors. The first is that for the repo rate to be effective, it must be transmitted correctly. In other words, banks must change their lending rates by the same amount and quickly,” he said. he explains.

The other factor highlighted by Sabnavis is that most consumption in India, and most items measured in the CPI, are consumed without any borrowing.

“People don’t borrow to buy food, consumer electronics, healthcare or rent. So loan rates have little impact on the purchase of these things and their prices,” he added.

An important factor to consider is that India’s high inflation is largely imported, as Finance Minister Nirmala Sitharaman and other senior officials have said.

Last year, India imported around 86% of its crude oil needs, meaning it is hostage to global oil prices, which have soared since the start of the war in Ukraine.

Data from the RBI and the Petroleum Planning and Analysis Cell (PPAC) of the Ministry of Petroleum and Natural Gas show that there has been a strong correlation over the past decade between crude oil prices and retail inflation in India.

Chart: Ramandreep Kaur |  The footprint
Chart: Ramandreep Kaur | The footprint

However, there is always a danger that higher interest rates will slow India’s economic recovery, which needs all the support it can get given the global headwinds from the war in Ukraine and global growth. staggering.

“When it comes to growth, investment demand is part of the aggregate demand story,” Pronab Sen, former senior economic adviser to the Planning Commission and former chief statistician of India, told ThePrint. .

“So if some of the investment demand is crowded out (because of higher rates), demand will fall, which means there will be downward pressure on growth. But that’s what you need to bring inflation down,” he explained.

But there are political benefits to being seen doing something about an issue like inflation. This is all the more important just before a critical election – such as the one brewing in Gujarat.

Read also : Why volatile food prices will keep pressure on India’s consumer inflation level this year

Demotivating work?

The other move that shows the government may be thinking more about electoral gain than finances is the extension of the PM-GKAY free food program for another three months.

The program, introduced in March 2020, was to run from April to June 2020. Extended several times since then, the program provides 5 kg of food grains per person per month free of charge to all beneficiaries covered by the Scheme. national food. Security Act (NFSA).

This equates to around 80 million people receiving 5 kg of food grain every month since April 2020.

The scheme, which was expected to have an expenditure of Rs 3.45 lakh crore – already a significant sum – before the extension announced this month, now has a revised expenditure expectation of Rs 3.91 lakh crore.

Although this free food, provided in addition to the NFSA entitlement, was of the utmost importance in the first year and a half of the pandemic, the extensions do not align with government claims of a robust economic recovery. , increased employment and increased economic activity in rural India.

There is anecdotal evidence in Europe and the United States that large social protection schemes allowed people to stay out of the labor market longer than normally possible. Worryingly, some of this anecdotal evidence has also started to come from rural India.

“There’s always a moral dilemma when it comes to giving away grants or items for free,” Sabnavis said.

“The danger is always that it could discourage behavior that is preferable. For example, loan waivers could discourage good borrower behavior in terms of timely repayment. Free food could also discourage low-wage workers from doing menial jobs,” he explained.

Sabnavis, however, is of the view that while the government can provide incentives to industry through production-related incentive programs, it can also provide subsidies to people who need them.

optical on economy?

On September 30, the Ministry of Finance announced that it would postpone the implementation of a tax on unblended fuel (which is not blended with ethanol and is considered “dirtier”) – a levy which had been announced in the Union budget 2022-23 presented on 1 February 2022.

“Fuel blending is a priority for this government,” Finance Minister Nirmala Sitharaman said in her budget speech. “To encourage fuel blending efforts, unblended fuel will be subject to an additional differential excise duty of Rs 2/litre from the first day of October 2022.”

However, the September 30 notification indicates that the deadline for the tax has been extended to November 1, 2022 for unblended gasoline and April 1, 2023 for unblended diesel.

“Our desire is not to collect this tax because the tax will be very minimal, but the desire is for the mingling to happen…to that extent it benefits the country,” Revenue Secretary Tarun Bajaj had said. , during the press conference following the announcement of the budget. .

If revenues will be low, of course the impact on the public will also be low. However, the prospect of postponing a tax hike is significant.

If India wants to reduce its dependence on oil imports, blending the fuel with ethanol is a must. A tax on unblended fuels is an effective way to encourage such blending. The postponement of the tax, largely for optics, will only delay the realization of India’s economic imperatives.

(Edited by Theres Sudeep)

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