Why in the News?
Despite headlines celebrating India’s less than 3% inflation rate in May 2025, deeper economic indicators tell a more troubling story. The same month saw a rise in unemployment from 5.1% to 5.8%, and GDP growth has slowed sharply from 9.2% in 2023-24 to 6.5% in 2024-25.
What caused the recent fall in inflation despite rising unemployment?
- Faster Agricultural Growth Narrowed Supply-Demand Gap: In 2024-25, agriculture grew faster than non-agricultural sectors, leading to an increased supply of food items. E.g., higher food production reduced scarcity, stabilising prices and easing inflationary pressure.
- Sharp Decline in Food Inflation: Food-price inflation fell from nearly 11% in October 2024 to less than 1% in May 2025. Eg: This drop significantly pulled down the overall Consumer Price Index (CPI).
Why is the RBI’s inflation control strategy being questioned?
- Mismatch Between Interest Rates and Inflation Trends: The RBI’s key tool—repo rate hikes—did not align with the sharp fall in inflation, especially food inflation. Eg: Despite no major repo rate hike since June 2022, inflation fell from ~11% in Oct 2024 to <1% in May 2025.
- Inflation Expectations Remain Unchanged: Household inflation expectations remained high and stable, even as actual inflation dropped, undermining the theory that RBI can anchor inflation through expectations. Eg: RBI’s own surveys (Mar 2024–May 2025) show expectations stayed well above the 4% target.
- Policy Reactivity, Not Proactivity: The RBI’s approach appears reactive, adjusting repo rates after inflation changes instead of steering inflation proactively. Eg: RBI Governor stated repo rates may be reduced if inflation continues to fall—indicating policy follows rather than leads inflation.
How does sectoral growth affect inflation?
- Balanced Sectoral Growth Reduces Supply-Demand Gaps: When agriculture and non-agriculture sectors grow at similar rates, it narrows the supply-demand gap, especially for essentials like food. Eg: In 2024–25, agriculture grew faster than non-agriculture, helping reduce food shortages and lowering food inflation.
- Agricultural Growth Directly Lowers Consumer Prices: A rise in farm output increases food availability, leading to a direct fall in food prices, which are a major part of the Consumer Price Index (CPI). E.g., food inflation fell from nearly 11% in Oct 2024 to under 1% in May 2025 due to a strong agricultural season.
- Wage Effects Spill into Non-Agricultural Prices: Lower food inflation slows down wage growth demands, especially for rural labour, which indirectly eases price pressures in services and manufacturing. Eg: Cheaper food reduces pressure on industrial wages, helping contain broader inflation in non-farm sectors.
What does the data say about interest rates and managing inflation?
- Weak Link Between Interest Rates and Inflation Control: Econometric studies show no conclusive evidence that interest rate hikes directly reduce inflation in India. Eg: Despite a repo rate increase of over 10% in June 2022, food inflation fell in 2025 largely due to improved agricultural supply, not rate changes.
- Sectoral Growth Differences Matter More: Inflation responds more to the relative growth of agriculture and non-agriculture sectors than to interest rate tweaks. Eg: In 2024–25, faster agricultural growth narrowed the supply-demand gap, lowering inflation, independent of any monetary policy shift.
- Inflation Expectations Remain High Despite Rate Hikes: Even with a tighter monetary policy, household inflation expectations remained above the 4% RBI target, questioning the effectiveness of interest rate-driven expectations control. E.g., from March 2024 to May 2025, inflation expectations stayed high despite stable repo rates.
Why should inflation and unemployment be assessed together?
- Inflation Control Alone Doesn’t Reflect Economic Well-being: Focusing only on low inflation can hide deeper problems like joblessness, which directly affects livelihoods. Eg: In May 2025, inflation dropped to 2.8%, but unemployment rose to 5.8%, showing a weak job market despite price stability.
- Policy Trade-offs Require Balanced Assessment: Sometimes policies that lower inflation may slow economic growth and reduce employment opportunities. Eg: Growth fell from 9.2% in 2023–24 to 6.5% in 2024–25, aligning with rising unemployment—highlighting that price stability came at the cost of jobs.
Way forward:
- Adopt a Dual-Mandate Approach: Policymakers, especially the RBI, should consider both inflation and unemployment while framing monetary policy—moving beyond inflation targeting alone.
- Promote Inclusive Growth through Sectoral Investment: Encourage job creation by investing in labour-intensive sectors like manufacturing, MSMEs, and services, while ensuring agricultural support to maintain price stability.
Mains PYQ:
[UPSC 2022] Besides the welfare schemes, India needs deft management of inflation and unemployment to serve the poor and the underprivileged sections of the society. Discuss.
Linkage: This question is highly relevant because it explicitly mentions both “inflation and unemployment” together and the need for their effective management. This article talks about the inflation has fallen, unemployment has risen, and it criticizes the focus on inflation while neglecting unemployment.
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