From UPSC perspective, the following things are important :
Prelims level : GDP Deflator
Mains level : Paper 3- Impact of inflation on various stakeholders
Recently, CPI inflation crossed the RBI’s upper limit of 6%. The article explains the implications of this for various stakeholders.
How inflation benefits government as a borrower
- Rising inflation hurts lenders and benefits borrowers.
- To that extent, the government, one of the biggest borrowers, stands to benefit as high inflation will lower the national debt load in relation to the size of the economy.
- The Union budget 2021-22 assumed a 14.4 per cent growth in nominal GDP, however, actual growth is set to exceed this.
- The GDP deflator, which measures the difference between nominal and real GDP, is a weighted average of WPI and CPI, with a higher weightage to WPI.
- And given that nominal GDP is used as a base for computing the fiscal ratios, all of these will get deflated.
- The value of past debt and debt servicing costs thus gets pared in real terms as inflation rises.
- Viewed from a debt dynamics perspective, as the gap between growth and interest rates rises, the debt/GDP ratio falls.
Impact on other stakeholder
- That inflation reduces purchasing power and hits private consumption is well known.
- Overall food CPI inflation (5 per cent) was lower than non-food inflation (7.1 per cent) in May.
- Lower food inflation, coupled with higher non-food inflation means reduced purchasing power for farmers.
- Inflation trends, specifically input prices (reflected better by WPI), matter for corporate performance as well.
- While producers seem to be bearing a part of the burden of rising input costs for now, these could get passed on in greater measure to consumers once demand recovers.
- Rising inflation reduces returns on fixed income instruments, including bank deposits, which account for over 50 per cent of households’ financial savings.
- This has already induced a shift to riskier asset classes such as equities, which has ramifications for overall financial stability.
- The RBI will have to closely monitor inflation trends and calibrate its policy response.
- It has not intervened on high inflation since the onset of the pandemic and, rightly so, in order to support growth.
- But the current spell of inflation is over a high base and a continuation of recent trends will persuade it to turn the focus back on inflation.
- Given the need for monetary policy to stay accommodative, it might be time to consider other supply-side interventions such as cuts in excise rates on petroleum products to soften the inflation blow.
Consider the question “As a one of the largest borrowers, how rising inflation benefits the government? How high inflation affects the other sections of the economy?”
Given the impact rising inflation has for the braoader sections of the economy, it is time for RBI to turn its attention to inflation.