India’s Monetary Policy Committee surprised observers in December 2019 when it decided not to cut interest rates, after five straight cuts prior. Every single one of the 34 economists surveyed by Bloomberg before the committee’s meeting expected a cut, and so the decision not to lower rates suggested the panel members were more worried about the state of the economy than analysts realised.
On Monday, the panel’s decision seemed to have been vindicated: Government data showed that retail inflation hit 7.35% in December 2019, the highest since 2014, and well above the permitted band of 4% with leeway of 2 percentage points on either side that the Reserve Bank of India is supposed to ensure. The spike was powered by vegetable prices, which were up 60%. But even if you look at food inflation without vegetables and pulses, which have seen the largest jump, it is still coming in at 5% which is a 33-month high.
The inflation spike comes just as the government confirmed that India is looking at 5% Gross Domestic Product growth for financial year 2019-’20, if not lower. Over the last year, data that has emerged about employment has also been worrisome, suggesting that joblessness is at multi-decade highs.
Low growth. High inflation. High unemployment. That combination is the definition of “stagflation”, a word that suggests a stagnant economy in which prices are stubbornly high. It is a peculiar phenomenon because conventional economic theory used to believe that high unemployment would automatically lead to low prices and vice versa. When that relationship is broken, the effects can be difficult for governments to handle and leave an economy bumbling along for years. Former Prime Minister Manomhan Singh warned that India was facing the dangers of such a phenomenon a few months ago, calling for immediate action to prevent it from setting in.
India is still not in a phase of stagflation, in part because most are expecting the inflation numbers to come down in the next few months as the winter crop is harvested and imports stabilise the situation. Even so, policymakers have every reason to be worried – both about inflation remaining stubbornly high for unforeseen reasons or, simply, that the economy is behaving in unpredictable waves.
Bloomberg’s economist survey, for example, produced a projected inflation number of 6.7%, a good 0.6 percentage points lower than the actual one. Similarly, none of the economists in December had expected the Monetary Policy Committee to keep rates steady. An unpredictable economy makes policymaking much harder, and also turns off potential investors.
What should the government do in the upcoming Budget? As we wrote last week, there is no silver bullet. The government’s finances are in a woeful position, giving it very little space to offer major stimulus, and even if it did so that might further drive inflationary tendencies. At the very least, the answer involves a deft combination of stimulus, incentives for businesses to invest more and a clear indicator to industry about the government’s objectives in its approach.
There is one thing that can help address the unpredictability at the very least. Over the last few years, Prime Minister Narendra Modi’s government has not owned up to the actual state of government finances. Using off-budget borrowings and other creative accounting techniques, it has hidden the full extent of the fiscal deficit. In the post-elections budget of July 2019, it also threw in extremely unrealistic expectations for the year head, even when it knew that those were based on flawed numbers.
Finance Minister Nirmala Sitharaman can use the upcoming Budget to come clean about the actual situation that the government finds itself in, while also providing transparency on official policymaking objectives. Forward guidance is the key to a stable economy. Any attempt at numerical chicanery would be counter productive.