RBI raises inflation forecast: What can the government do to stem inflationary pressures?

RBI in its monetary policy review raised its inflation forecast for the current fiscal year from 5.1 per cent to 5.7 per cent. Maintaining an accommodative stance to support growth, the central bank kept the repo rate unchanged at 4%. Even as it expects the inflationary pressures to be transitory, RBI has highlighted the need for all round support for economic recovery to sustain and inflation to come down.
RBI's assessment of inflation
The central bank observed that Consumer Price Index (CPI) inflation "plateaued" to 6.3% after rising 207 basis points in May.Going forward, the revival of south-west monsoon and the pick-up in kharif sowing, buffered by adequate food stocks should help to control cereal price pressures, the policy statement notes. High frequency indicators suggest softening of price pressures in edible oils and pulses. This is in response to supply side interventions by the government, it said. Input prices are rising across manufacturing and services sectors, but weak demand and efforts towards cost cutting are tempering the pass-through to output prices, it adds.
Taking into consideration all these factors, CPI inflation is projected at 5.9% in Q2; 5.3% in Q3; and 5.8% in Q4 of 2021-22.
"The current assessment is that the inflationary pressures during Q1:2021-22 are largely driven by adverse supply shocks which are expected to be transitory. While the Government has taken certain steps to ease supply constraints, concerted efforts in this direction are necessary to restore supply-demand balance. The nascent and hesitant recovery needs to be nurtured through fiscal, monetary and sectoral policy levers," the Monetary Policy Committee (MPC) statement says.
What can the government do?
Madan Sabnavis, Chief Economist CARE Ratings Ltd doesn't see any immediate possibilities for action on the supply side. "Inflation, though projected under 6% for the entire year, is still very high at above 5%. From a supply side perspective there is little that can be done on an immediate basis," he says.
"Prices of edible oils are high because of global factors. In the case of pulses, as stocks run down towards the end of year there is tendency for prices to increase. Food inflation has been high because of these two major components and there is not much that the government can do about it," he tells TOI. "The demand supply mismatch exists not because demand is high, but because supply is constrained. The only thing that can be done, and the RBI has been talking about it for some time now, is that taxes on crude oil can be reduced," he adds.
Even in its policy statement last week, the RBI advocated a reduction in indirect taxes. "With crude oil prices at elevated levels, a calibrated reduction of the indirect tax component of pump prices by the Centre and states can help to substantially lessen cost pressures," MPC said.
DK Srivastava, Chief Policy Advisor at EY India also sees some scope for reduction in taxes on petroleum products. "Initial indications suggest that the first quarter tax collection numbers will be good. This may open up some fiscal room for the government. The government can front load expenditure to ease supply side constraints," he tells TOI.
"Also, there may be scope to reduce taxes on petroleum products. Global crude oil prices are expected to largely remain stable in the coming quarters, and with decent tax collection, the government may find some room to cut taxes on oil," he says. "Some Centre-State coordination on taxes on petroleum products may also help ease inflationary pressures," Srivastava adds.
Better Centre-state coordination is also prescribed by Sachchidanand Shukla, Chief Economist at the Mahindra Group. "Proactive Centre-State coordination in terms of easing supply bottlenecks, imposition & enforcement of lockdowns as well as reopenings will be key to handling supply-side constraints," Shukla tells TOI. "The RBI spoke about the need for support from the fisc in the last policy and has asked for support from 'all sides'. Importantly, GoI has been paying heed by way of measures on oil seeds, fertiliser subsidy, pulses etc," he says.
According to Shukla, there is now a need for much broader support including from concerned ministries and even state governments to tackle specific factors to alleviate the supply side issues that aggravate inflation.