Can quantitative easing work in India with 7% inflation?

The anguish is palpable. First, it was the news that India’s nominal gross domestic product is growing at its slowest pace in more than four decades. Now comes the inflation data for December, showing the steepest rise in consumer prices since July 2014. If this is the onset of stagflation, then it will be very hard to beat back the blues. But is that what we’re seeing?
The risk of economic stagnation combined with high inflation has indeed risen, though the former remains the dominant force. For the central bank to get nervous and switch prematurely to a hawkish stance would be a grave error. Even if it can’t reduce interest rates any further this year, the Reserve Bank of India should keep quantitative easing among its options for supporting the economy.
Last month’s jump in inflation to 7.35%, way above the central bank’s 2% to 6% target range, was driven by food. A vegetable shortage has been emerging for some time, and that’s now making substitutes such as eggs, milk and fish more expensive, too. With food prices increasing globally, it’s hard to predict just when the Indian situation will ease.
However, core inflation, which strips out volatile food and fuel, is more under control. It inched up to 3.75% after mobile-services firms bumped up fees and rail fares rose. Still, corporate insolvencies are pushing joblessness higher. New investment — and hiring — are muted. This will constrain wages and producers’ pricing power. While headline inflation will eventually weaken and head towards the core rate, economists expect it to stay above 6% for 2020. That would crimp the RBI’s ability to add to last year’s five rate cuts.
The monetary authority’s support can still make a difference, but only if it alters the strategy of buying government bonds from banks. With deposit-taking institutions sitting on excess liquidity of $45 billion, pumping more cash into an overflowing pond is increasingly pointless. Lubrication is needed elsewhere, and the way to provide it will be for the RBI to start buying assets from insurers, mutual funds, housing finance companies and other lenders that don’t take deposits.
Recommending Federal Reserve-style quantitative easing when inflation is above 7% sounds like a plan fraught with risk. It needn’t be.
Right or wrong, the price statistics are likely to have a bearing on what Prime Minister Narendra Modi’s government does in its February 1 annual budget. Any fiscal adventurism, such as deep cuts to income taxes, will need a rethink. Now that the bond market must rule out further rate cuts this year, it may not be in a mood to supply funds for a bulked-up borrowing program. Why should investors accept 6.5% yields on 10-year notes with expected inflation at 6% or higher? Last week, the sovereign yield jumped as much as 10 basis points, the most since December 5. Given its funding constraints, the government still needs the monetary authority to do the heavy-lifting.
For the central bank to throw in the towel now would only worsen the stagnation.

—Bloomberg

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News