After a quarter of world beating economic growth and inflation close to target, India has, for now, struck a growth-inflation balance it has coveted for some time.
For the April-June quarter, average inflation was running at 4.8 percent. This, while GDP growth hit a nine-quarter high of 8.2 percent. In the current quarter, growth is seen at between 7.2-8 percent, according to the RBI’s projections. Average inflation, over this period is seen at 4.6 percent.
Is this a passing ‘Goldilocks’ phase for the economy? Or have structural changes helped? Economists have differing views.
Is Inflation Targeting Working?
One view is that inflation targeting has, in part, helped keep inflation in check.
India formally adopted an inflation target in March 2015. This came after a committee headed by now governor Urjit Patel recommended that retail inflation be made the nominal anchor for monetary policy. After discussions between the government and the RBI, a flexible inflation target of 4 (+/- 2) percent was set.
Inflation has remained within that band since August 2014, although it is yet to move to the 4 percent mid-point of that band in a sustainable fashion. To be sure, low global oil prices for most of this period have played a key role. As have lower food inflation. Core inflation, which is not formally targeted by monetary policy, has oscillated in a wider band of 3.8 to 6.4 percent.
The inflation targeting framework has been a key factor in bringing down inflation expectations, said Pranjul Bhandari, chief India economist at HSBC. “The inflation targeting regime has been one of the top reforms, almost as significant as GST and the Bankruptcy Code,” Bhandari told BloombergQuint in an interview on September 1.
Rupa Rege-Nitsure, chief economist at L&T Finance and one of the members of the expert committee that recommended inflation targeting, also believes the framework has seen some early success. A targeted monetary policy framework brought discipline to markets and ended speculation about policy rates, she said. “Now, monetary policy is rule based rather than discretionary.”
That low and stable inflation is essential for economic growth, is a widely accepted tenet in economics. With two consecutive rate hikes in June and August, the Monetary Policy Committee (MPC) has reaffirmed its emphasis on reining in inflation while supporting growth.
However, India is a developing economy and remains vulnerable to shocks beyond the control of monetary policy. The MPC’s actions may be necessary but not sufficient in maintaining a healthy growth-inflation mix, says Rege-Nitsure.
Is Potential Growth Higher Than Believed?
Another analysis of the current growth-inflation mix suggests that India’s potential growth is higher than the 7-7.5 percent that it is currently believed to be.
Abhishek Gupta, India economist at Bloomberg Economics, estimates India’s potential growth at around 8-8.5 percent, above most other estimates. “The pickup in in growth, without demand driven inflationary pressure in the economy, supports our thesis that reforms have lifted India’s potential growth,” Gupta wrote in a report dated September 3.
The report noted that though GDP growth is expected to trend down in the remaining quarters of the year, structural reforms indicate a broad based recovery that is expected to get stronger.
Even so, growth may remain below the potential estimated by Bloomberg Economics. As such, Gupta expects the output gap to remain negative and continue to put pressure on core inflation. That view is contrary to the widely-held belief that the output gap is now closing, justifying the MPC’s concerns about a likely pick-up in inflation pressures.
Is This A Passing Phase?
A third, and perhaps most likely explanation, is that India and other Asian economies lucked-out because of an extended period of low oil prices.
Low inflation was driven by temporary forces, said the IMF in its Regional Economic Outlook in May. The fall in commodity prices helped import more and as commodity prices see a reversal, inflation may rise, the multi-lateral agency said. The IMF recommended that central banks allow exchange rates to adjust to tackle imported inflation.
As oil prices rise and currencies like the India rupee weaken, inflation may start to rise, said Aditi Nayar, economist at ICRA. Besides, quarterly economic growth and inflation have both shown significant variability, she said.
The IMF threw in some other possible reasons which may have altered inflation dynamics. For one, China seems to have played an important role in driving both global and regional inflation, said the IMF.
The fund also highlighted the role of technology. In Asia, these appears to be a link between the flattening of the Phillips curve and automation (in advanced economies) and between inflation and integration in global value chains. To the extent that automation substitutes, or threatens to substitute, for some low- or middle-skilled workers with routine job tasks, it could weaken the power of such workers to bid up their wages.
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