Three-pronged approach to tame India's inflation

There is a well-known debate among economic policymakers regarding a more efficient way of giving government subsidies. Should it be in kind or in cash? The proponents of the in-cash method prefer a direct money transfer to the poor, and then the poor are free to use that cash as they wish. When the Jan Dhan Yojana was rolled out, opening no-frills bank accounts to now nearly 450 million people, direct money transfers became easy. This was also because bank networks are electronically linked. Direct cash support rather than in-kind support is more efficient in many cases. But since March 2020, the government has been giving in-kind benefits like food rather than cash. The Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) gives 5 kilo of food grains (wheat or rice) and 1 kilo of pulses free, per person per month, to every household holding a ration card. This welfare scheme is the largest food security scheme in the world, having now fed an estimated 800 million people.

Initially, the scheme was to expire in a few months in 2020, but has been repeatedly extended, and is now set to be discontinued from September 2022. The point is that the subsidy is given in kind, not in cash. During the time that food prices are going up, and wheat prices have gone sky-high, imagine the plight of the poor if they had got only cash and not food grains instead. The inherent weakness of in-cash subsidy schemes is that they do not protect the recipient from inflation. Of course, there could be other problems with cash deposits, like a wrong deposit in another bank account, or cyber fraud. In the case of grain distribution, it is given in-kind so its value does not get eroded by inflation. There is, however, a huge logistical challenge for the government to ensure that the grain and cereal reach every nook and corner of the country, without leakage or corruption. But on this front, especially with the help of state governments, food distribution has been reasonably successful.

The food entitlement in PMGKAY follows the National Food Security Act passed in 2013. The latter envisaged in-kind benefits of grain to be sold at Rs 3, Rs 2 and Re 1 a kilo of rice, wheat and coarse cereal, respectively. PMGKAY made it completely free, and to a large extent helped ensure food security during the pandemic when jobs and livelihoods were lost. It is speculated that the welfare scheme also had an impact on several state election outcomes.

The in-kind food distribution scheme is an administratively complex arrangement that was most appropriate at the time of the pandemic and food inflation. It helped address food security as well as food price stability (since the recipients were protected from food inflation).

As we grapple with the severe impact of oil price inflation caused by the war in Ukraine, and high commodity inflation, at least for food inflation the government might have to extend the PMGKAY. But bear in mind that the scheme will entail a steep fiscal cost -- of procuring the grain at high prices and giving it away free, plus the cost of storage and transportation. Even then, this fiscal cost and administrative measure are more effective than merely monetary measures undertaken by the Reserve Bank of India.

The government also took the bold decision of an abrupt U-turn regarding wheat exports, by banning such exports to ensure domestic food security. Of course, it is awkward for India to announce to the world that it would “feed the world” and not restrict wheat exports in March, and within two months do an about-turn. This was necessitated due to the realisation that there is a steep drop in wheat yields this year, and we may not have an adequate surplus for exports.

For its part, the RBI too did an abrupt U-turn earlier this month by suddenly raising interest rates and the cash reserve ratio (CRR). The raising of the CRR resulted in the removal of 12% of liquidity i.e. nearly Rs 90,000 crore of the money supply. This tightening of the monetary stance was quite contrary to what the RBI has been saying for many years. It was the first tightening measure since 2018. During the pandemic period, the RBI provided plenty of liquidity, estimated at 8% of the GDP, kept interest rates very low, and also helped with other measures like the loan repayment moratorium.

But while the RBI’s accommodative policies might have helped the economy, the excess liquidity had some perverse effects -- the funds poured into the stock market (and also housing) leading to a possible bubble, for one. The increase in stock market wealth goes mainly to the rich, and that wealth remains untaxed since those are unrealised gains. So, it does not help the fiscal deficit. The other effect was that inflation remained too high, even prior to the pandemic. For more than two years, the average inflation rate has been close to 6%, which is the upper band of tolerance for the RBI’s Monetary Policy Committee. The wholesale price index inflation has been 14% for more than a year. Why was it not tightened much earlier, by raising rates? But it chose forbearance, perhaps keeping in mind the weak economic recovery, or perhaps because it wanted to help the government’s borrowing programme.

The biggest borrower by far in the banking system is the Government of India, and keeping interest rates low, helps it. The annual borrowing requirement is close to $14 trillion this year alone. The total sovereign debt has already climbed close to 90% of the GDP. So, even a one per cent rise in interest rates could spell an additional interest burden of close to Rs 70,000 crore. No wonder the rate hike decision has great significance.

The RBI must have finally agreed to bite the bullet, for not only is inflation galloping, but the rupee-dollar exchange rate is also sliding down. So, to attract more dollars into the bond market, the interest rates in India need to be higher than in the US.

Clearly, we face multiple challenges of inflation management, food security and of staving off recessionary fears as investors become cautious. It is going to be a difficult year for the economic policy, and all tools including fiscal, monetary and administrative controls will be needed to keep inflation low.

(The writer is an economist)