Wednesday, June 19, 2019
Home > Indian Economy > Structural Reforms The Key To Lowering Inflation and Fiscal Deficit

Structural Reforms The Key To Lowering Inflation and Fiscal Deficit

So, really what was the first and the most important thing that needed to be done when this government came to power in 2014, was to impose some sort of an order on the system. So, what was the first reform that this government attempted to do was to introduce something called the “monetary policy committee”, with very very strict targets for inflation control. Why this was because, until you have anchored inflation, nothing else can work. So, the RBI act was amended, a monetary policy committee was formed, with very clear target of an average of 4%, a midpoint of 4% with a range of 2% points on either side. So, a range of 2-6% for inflation. And this has been hugely successful. So, nobody imagined that we would manage to lower our inflation rate which used to run historically in the 8-10% range. In fact, very often was it double digits, to one where we are very comfortably managing to control inflation.

So much, so, some people would argue we have been too successful in fact the only time inflation has actually hit the edges of the target range is actually to the down side. It went out of it in 2017, and we are actually hitting it as we speak right now. The inflation as we speak is around 2%. And there is some argument, to say, it may even be overstating the number. So, this is a huge huge achievement. Any other country that was attempting to do structurally lower inflation by 500 basis points or thereabouts of what we were attempting to do, would have gone in to a complete recession. And yet we have done it. It’s not something we are claiming to do. We have done it. Yes, it was very painful. Because when you suddenly lower inflation in this way, real interest rates go spiraling out. And of course, it causes pain, particularly to the business community. But generally, even to the government, because obviously the real interest rate it was paying on government debt went spiraling out as well. So, what we ended up with of course was painful. For example, even today a small business pays 12% on its debt. With inflation running at just 2% you can imagine the thousand basis point real interest rate is being paid by the business community. Very very painful. And I will come back to this issue a little bit later. But, the first step in terms of radically lowering inflation rates has already been achieved.

Now, why is this such a great and important achievement. Because, you see, until you have anchored inflation on a long-term basis, on a structural basis, you cannot bring down the cost of capital. And why do we need to bring down the cost of capital? Well because if you don’t bring down the cost of capital, then all the other problems that we try to solve will not get solved. So, for example, we talk about the fiscal deficit. Now, the primary deficit, i.e., the deficit of the central government excluding the amount that we pay on existing debt is only 0.2% of GDP. In other words, for all the things that the finance minister actually has control over is actually doing a very good job.

We only have a primary deficit of 0.2% of the GDP. So where does 3.4% of GDP deficit come from? Well all of the rest is, interest payments on past accumulation of debt. So really we are all running very very fast, just to stay at the same place. And until you can structurally lower the cost of capital, you cannot fix the fiscal deficit.

Leave a Reply

%d bloggers like this: