While the Reserve Bank of India did its part with interest rate increase to cool inflationary pressures, the government appears to have done more to contain the key item in the inflation basket – food.
Economists including at Goldman Sachs say that government measures – release of stock, selective curbs on exports, and raising imports – have done more to keep a lid on prices skyrocketing.
Even as global food and fertilizer prices rose following Russia’s invasion of Ukraine, food price inflation in India remained relatively muted. “ Higher subsidies on fertilisers and excise-duty cuts for petroleum products have blunted the inflationary impact of the Russia-Ukraine war, which has contributed to reducing inflation differentials between India and the rest of the world” , said Rahul Bajoria, chief India economist at Barclays Capital.
The central government undertook two main measures to absorb the commodity supply shock which followed the pandemic shock. It increased food subsidy by Rs 1.3 lakh crore (0.5% of GDP) from the budget estimate of Rs 2.1tn (0.8% of GDP) and distributed a total of 20.2mn tons of rice and 12.2mn tons of wheat since March 2022 under the public distribution system at subsidized prices. “The fertilizer subsidy helped contain food inflation by partly arresting pass-through of farm input costs to food inflation” said Santanu Sengupta, chief India economist at Goldman Sachs. While farm input inflation rose by around 25%, according to economists’ estimates, food inflation was contained around 6 percent as a result.
The government fiscal concessions were possible due to fiscal space created by buoyanyt revenues and may not be harsh on the overall fiscal health. “ Strong revenue, particularly from direct and indirect taxes, has been a key tailwind to consolidation efforts, also benefiting from hastened formalisation and better due diligence. This has helped to offset a bigger subsidy bill, undertake administrative measures to absorb price increases “ said Radhika Rao, senior economist at DBS Bank. “ With energy prices coming off the boil and inflation peak behind us, the policy committee is expected to retain a hawkish tilt but move in smaller increments”.
But fiscal policy would need to be restrictive over the longer period. “This means that fiscal policy, while expansionary in the near term, will need to turn slightly more restrictive in the medium term — which could either push up inflation (through GST or fuel duty hikes), or push down growth (through expenditure rationalisation) — which should help to ensure macro stability in the medium term” said Bajoria.
Goldman Sachs forecasts headline CPI inflation to decrease to 6.1% year-on-year in 2023 from 6.8% y-o-y in 2022, as active government intervention is likely to cap food inflation. Going forward, it sees some upside risk to cereal inflation due to estimated decline in production, and depletion of inventories. Also, sowing of pulses in the Kharif (summer) season was 6% less compared to last year and is likely to affect its production.
“ Given upside risks to core services inflation, and India running negative real rates, we think the RBI is likely to hike the repo rate by 50bp in the December 2022 policy meeting, followed by 35bps in the February meeting which would take the repo rate to a peak” said Sengupta.