*****India won’t collapse like Sri Lanka or Pakistan but we are certainly in trouble: Swaminathan Aiyar – The Economic Times

clipped from: https://economictimes.indiatimes.com/news/economy/policy/india-wont-collapse-like-sri-lanka-or-pakistan-but-we-are-certainly-in-trouble-swaminathan-aiyar/articleshow/91685298.cms

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India won’t collapse like Sri Lanka or Pakistan but we are certainly in trouble: Swaminathan Aiyar

ET NowLast Updated: May 20, 2022, 03:16 PM IST

Synopsis

Prices of commodities, services, manufacturing have been soaring in the last 12 months. Inflation began in 2021 and the Ukraine war only accelerated it. The world is caught in a huge inflationary trap right now .

The world has been hit with a double whammy – on one hand there is a recessionary trend with demand falling, at the same time prices are going up. Central banks around the world took inflation too lightly, says Swaminathan AiyarStagflation signs are around. While we may not collapse like Sri Lanka or Pakistan but we are certainly in trouble, he believes.

Excerpts…

How real is the fear of rising rates that is making global markets nervous?
We are at highest rate of inflation in years. The wholesale price index for April had just come in at 15.05%. The consumer price index 7.8%. These are extraordinarily high rates and there is nothing special about India. In America where the target inflation is 2% their latest inflation rate 8.5%, it came down a little to 8.3%. So there is global inflation.

Prices of commodities, services, manufacturing – have been soaring in the last 12 months. The inflation began in 2021 and the Ukraine war has accelerated it. The world is caught in a huge inflationary trap right now . The physical shortage of a large number of commodities has been building up over time, and over and above that came the shock of war and the sanctions imposed on Russia, which is an important supplier of number of items. The Black Sea, which is one of the greatest supply routes out of Russia and Ukraine, has been blocked by the war.

On top of everything else China has committed a kind of hara-kiri by having a complete lockdown in an attempt to stomp out COVID – so there is a separate supply shock because there is no production going on in China. These different strands have all come together for a gigantic shock.

We are in a situation where on the one hand there is a recessionary trend, recession is coming because demand is falling, at the same time prices are going up. Some people call this stagflation.

In the case of India we have been hit both ways. We were expecting this to be a very good year for growth. The World Bank, IMF had said India would be the fastest growing major country, and perhaps that will still be the case but earlier they were hoping for 9% growth or things like that, now people say maybe 7%, 7.5%, maybe 6%. So, we are in a tough position right now with inflation is rising fast because inflation is rising everywhere else in the world and because of that we cannot escape it alone and the downtrend, the recessionary trend is also coming the world over and we cannot escape that. We are perhaps better positioned to withstand the problem that some other countries. We will not collapse like Sri Lanka or Pakistan but we are certainly in trouble

Do you think the situation is under control. Can central banks control inflation just by raising the rates?
Raising interest rates is not going to solve the supply problem. Raising interest rates is a way of– if there is an overheated economy with too much demand then you can say I want to slow down that demand by raising interest rates and making it difficult for people to buy but that is not the case today. India does not have an overheated economy where there is too much demand, in fact there is not enough. Take a look at the India Inc earnings – the auto sector is not in good shape, demand is low and so production is also being affected.

There is a shortage in areas like metals but even there the prices have come down very sharply. So right now, the problem of inflation cannot easily be solved by tightening the interest rates. It can be tightened in some cases, the government is trying to do it in the case of wheat by putting an export ban. If you look at the world price of wheat it costs about Rs 40 a kilo and if we freely allow the export of wheat and all our surplus buffer stocks we can have a huge export boom but then if the Indian price equates with the world price at Rs 40 a kilo there will be mayhem and there will be riots on the streets so the government has tried to do supply management by saying we will stop all exports of wheat.

This I think was a bad move, I mean it should have been more gradual and they should be allowing some exports but right now that is one thing that they can do. They have put a ban to improve the supply of wheat and this can help to reduce inflation on that front. Beyond that you will have to live with the global trends, you cannot wish away the global trends and just as Indonesia has put this restriction on edible oil, we are a very large importer of edible oil we are going to suffer.

The government up to a point can reduce import or excise duties on commodities like edible oil, crude oil, petrol, diesel – but all this would be limited amount of relief. It is not the case that prices will come down but you can you can limit the extent to which the prices rises beyond that you will have to wait for this war to play out and for this business cycle to play out, those are items beyond your control.

What do you think is the best course of action for the RBI now?

Central banks around the world, including the RBI, were too relaxed about inflation. They kept thinking this is some temporary delaying it will go away. Then they thought that some increase has taken place last year it will go away then they thought no, then when the war came then again people thought that this may be just temporary, there will be a quick solution to the war.

There is no quick solution to the war and it has now become very clear that inflation has gone out of control compared with what you expected it to be.

In America the target is 2% and it went to 3-4% they said you know okay it could come down again instead it has gone to 5%, 6%, 7%, 8%, 8.5% so panic has broken out there and they are tightening and tightening. The RBI cannot afford to be left out and therefore the RBI has been reluctant to raise interest rates but when everybody else is doing it they say we will have to do so because if we do not do so there can be an attack on the rupee.

You cannot have a situation where everybody else just raising the interest rates and India is not, if you do that huge amount of money can flow out of India so because of that the RBI reluctantly is increasing its rates and will continue to raise its rates there is no option and apart from protect any our foreign exchange reserves it will also help tame inflation up to a point.

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