In the recent past (since May 2022) RBI has hiked the repo rate by 140 basis points i.e., 40 bps in May, 50 bps in June, and another 50 bps on 5^th August, 2022. There are divergent views on the likely impact of this move by RBI. While few experts say that this is a much-required move and it is in the expected direction which will curb the increasing inflation, whereas those who differ say that post covid when the Bharatiya economy is showing signs of recovery increase in repo rates will make cost of funds more expensive to the banks leaving them with no option but to increase the interest rates, eventually putting speed breakers in the path of recovery of our economy. 

Inflation is a result of price rise as everyone knows. However, price rise can be either due to increase in demand (when the supply remains the same) or due to reduction in supply or increase in the cost of factors of production (assuming the demand remains the same). Therefore, let us look at the data and analyze the same to ascertain the root cause of our current inflation.

Bharat’s GDP Growth Rate- Historical Data

Post 2016 our GDP growth rate started declining and during covid we witnessed a negative growth of – 6.6% in 2020.  However, with GDP annual growth rate of 8.95% in 2021 in due course Bharat‘s GDP has reached its pre pandemic levels as under. 

Real GDP in the second quarter (July-September 2021) was estimated at Rs 35.73 lakh crore, marginally exceeding the pre-pandemic levels of first quarter of 2019-20 (April-June, 2019) of Rs.35.66 lakh crore and second quarter of 2019-20 (July-September, 2019) of Rs.35.61 lakh crore. 

Bharat’s Unemployment Rate – Historical Data

During July 2017 to June, 2018 unemployment rate reached the highest in the 45 years at 6.1%. post pandemic the unemployment rate shot up to 8% in 2020 though it had declined to 5.98% in 2021 thanks to the revival of our economy. 

Decline in Private Consumption

Private consumption as a share of nominal gross domestic product which was 60.5% in 2019-20 declined to 58.6% in 2020-21 and further declined to 57.5% in 2021-22. During 2012-14 it was 71.5%, whereas during 2015-19 it came down to 69.8% and in June 2020 it declined to 57.1%. private consumption rose to 60.58% of GDP in QI/2021, 63.23% in Q4/2021 but again declined to 59.22% in Q1/2022. 

• Declining GDP growth rate, increasing unemployment rate and reduction of private consumption as a share of GDP clearly suggest that overall demand in the economy is declining. 

      Bharat’s Inflation Rate – Historical Data

Inflation in the year 2022 ended at 6.16 %. Inflation has been on the rise since 2020 (i.e., post pandemic). It is evident that the supply chain disruption due to lock down has led to bottlenecks in the production, supply and distribution of goods and commodities resulting in price rise. This is further accentuated by Ukraine-Russia war resulting in price rise in crude oil, edible oils and other food items. Added to this rupee weakened against dollar leading to increase in overall import costs, which in turn fuelled the inflation. 

Therefore, we can conclude that supply chain disruption post covid and hike in imports cost due to Ukraine-Russia war and appreciation of dollar against rupee have had a multiplier effect on Bharat’s inflation. Hence, our current inflation is mainly due to cost push factors but not demand-pull factors. 

The argument put forth by some experts who say repo rate hike will stall the outflow of funds from Bharatiya capital markets to USA is a debatable point. The current on-going Ukraine-Russia war has also triggered the currency war and Russia is defying US sanctions through de-dollarization with the support of China and also working towards having trade in national currencies with its trading partners. US Federal Reserve too has been hiking its interest rates in the recent past to fight inflation attributing the same to supply chain issues and broader price pressures in food and energy items. Hike in interest rate will also help US to retain and gain more global investments into its economy which will be part of its strategy of retaining its currency supremacy globally. 

Monetary policy can only be effective in controlling the volume of money in circulation to a greater extent and the inflation caused by too much money chasing too few goods and commodities. Therefore, when the current scenario is one where the inflation is caused by supply side issues, there is a danger of hike in the interest rates leading to further increase in the cost of goods and commodities as the cost of capital/borrowings will increase due to the increase in the interest rates. This may in turn adversely affect the demand in the economy which is slowly reviving in the recent past. Hence, the need of the hour is to address the supply side issues while taking measures to revive the demand in the economy simultaneously. 

Capital Expenditure:

“Private sector capex, which peaked in FY11 at Rs 3.7 trillion, has been on a declining trend since the past seven years. During FY18, it has hit its lowest level to Rs 1.5 trillion since FY07, declining 13 per cent on a year basis”, (Motilal Oswal Financial Services, 2019). 

One of the reasons behind shrinking private sector capex is obviously the overall decline in the demand in the economy. 

The central government’s budgeted allocation for capital spending in FY 2021-22(BE) was Rs 5,54,236 crore, up 34.5 percent over FY 2020-21. Whereas, the actual amount spent was only Rs. 2.74 lakh Crs! Capital expenditure in the Budget 2022-23 has been increased by 35.4 percent over the previous year’s budget forecasts to Rs 7.5 lakh crore. Incidentally, the states spent more on capital expenditures than the Union government. States spent Rs 4.46 lakh crore in FY21, while the Centre spent Rs 4.12 lakh crore.

National Infrastructure Pipeline

Under the NIP the total capital expenditure in infrastructure sectors in Bharat during fiscals 2020 to 2025 is projected at ~Rs 111 lakh crore with the funding pattern envisaged as under.

• Centre 39%-    Rs. 43.29 Lakh Crs
• States  40% –   Rs. 44.40 Lakh Crs
• Private 21% –  Rs. 23.31 Lakh Crs
• Total            – Rs. 111.10 Lakh Crs 

As many as 144 central infrastructure projects are under execution at various stages wherein the total anticipated cost is expected to increase to Rs 1,82,453.84 crore, from Rs 1,67,493.82 estimated originally, resulting in an overall cost escalation of Rs. 14,960.02 Crores (as per the government’s submission to the parliament in December, 2021). 

Way forward 

In order to speed up the momentum in revival of the demand in the economy, the government has to first kick start the execution and timely completion of these 144 central infrastructure projects avoiding further cost escalation. This would increase the demand for steel, cement and other construction materials, in turn resulting in a multiplier effect in the economy across various sectors thereby providing additional employment leading to increase in the private consumption and overall demand in the economy.

This will pave the way for smooth launching of the above-mentioned National Infrastructure Pipeline wherein the States and private sector would find the economic climate positive for additional capital investment. Needless to say, these projects would improve the quality of physical infrastructure in the country thereby reducing the supply side bottlenecks in the long run. Hopefully by that time the global economy would come back to the path of recovery and growth.