Taming inflation: How Union Budget can address economic challenges

By easing supply-side constraints and using counter-inflationary tariff policy, the finance ministry can ensure prices remain in check

Budget 2025 will be presented against the backdrop of a cyclical slowing of growth to a two-year low (5.4 per cent in Q2-FY25) and persistent concerns over inflation. This two-front economic challenge and the appropriate monetary policy response to deal with it have led to sharp differences of opinion within the Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) and among economists.

 

Very little attention is being paid to the role of the fiscal authorities in mitigating the costs of the inflation-growth trade-offs. Budget 2025 is an opportunity to address some of these dilemmas and, in the process, improve the efficacy of monetary policy.

 

Take the case of food prices, the main driver of headline inflation and the bone of contention between the monetary “hawks” and “doves”. During the last decade, food price volatility has remained unaffected by interest rates, lending credence to the claims it is a purely supply-side phenomenon.

 

True, weather and other supply-side disruptions are crucial factors behind food price volatility. But there is more to the issue than meets the eye. Counterintuitively, elevated food inflation over most of the last decade has been accompanied by rising consumption levels for food and non-food goods across the board.

 

According to the Household Consumption and Expenditure Surveys 2023 and 2024, since 2011-12, the food basket has become healthier as shares of milk products, fish & meat, and fresh fruits have increased for all income strata. Another indicator of rising income levels is that the share of food in the consumption basket has come down across the board. The dietary improvements are striking for the poorest 20 per cent in rural and urban areas. Poor households experienced a relatively significant increase in expenditure shares of milk products, eggs, fish & meat, and fresh fruits.

 

Therefore, food inflation seems to be, at least in part, driven by the income effect, powered by direct income transfers (e.g., PM-KISAN, pensions), free or subsidised food, and other “freebies” provided by the Centre and states. These fiscal transfers are here to stay, for political economy reasons. They, in effect, increase the beneficiaries’ purchasing power, which is used to buy non-food items and services. This inference is further corroborated by steady rural demand for two-wheelers and relatively low-price fast-moving consumer goods in rural basket, even in the face of relatively high inflation. To the extent driven by the income effect, food inflation, rather than hurting the poor, seems to manifest improved welfare.

 

At the same time, post-harvest losses and rotting stocks due to inadequate storage capacity restrict supplies and thus significantly contribute to vegetable and fruit price inflation and volatility, especially for potatoes, onions, and tomatoes. The onus lies with the Centre and state governments. 

 

To ease food inflation, Budget 2025 should focus on cold storage, warehouses and transportation logistics. Such facilities should be developed and run on a public-private partnership basis for efficiency gains. Irrational caps on storage and load capacity should be removed to attract private investment. Budgetary support should be increased for R&D, extension services, and price support to improve the productivity of edible oil crops, which are a leading cause of food inflation and avoidable import bills.  Customs duty on food items should also be anti-inflationary.

 

These measures will reduce food inflation, creating enough elbow room for the RBI to cut interest rates to provide the much-needed boost to private investment and consumption. Sticking to the fiscal glide path and restricting the fiscal deficit to 4.5 per cent of GDP will also help.

 

The effectiveness of interest rate cuts in inducing investment will depend on domestic demand prospects. Labour market conditions also play an important role. The usual status unemployment rates have reduced drastically to 5.7 per cent and 3.5 per cent for urban and rural areas, respectively. However, there is slack on the wages front—real wages growth is modest for semi- and mid-skilled workers. This manifests in the subdued middle-class demand for discretionary items—small houses, sedans, hatchbacks, etc.

 

Greater fiscal and administrative support is needed for the success of employment-linked incentive schemes to improve labour market outcomes. The PM internship scheme — monthly assistance of ~5,000 for the 12-month internship—needs to be scaled up to achieve the target of 10 million beneficiaries over five years. To make it popular and successful, the scheme should be integrated into the academic curricula of vocational universities.

 

There is a chorus demanding income tax rate cuts to boost demand from the middle class. The fact is that most of the “middle class” pays very little income tax. In the assessment year 2023-24, only about 3.4 per cent of the adult population of India actually paid any income tax. The income tax rate cuts will help boost demand but for the upper middle and top-income groups. Benefits of goods and services tax rates are better to boost demand of low- and middle-income groups.

 

To revive middle-class demand, we must rev up India’s economic engine, powered by 60 million micro, small and medium enterprises (MSMEs), which account for about 250 million jobs and 45 per cent of exports. They borrow at usurious rates ranging from 24 per cent to 36 per cent. Unsurprisingly, many end up with special mention accounts or non-performing assets. According to estimates, 1.2 million jobs at stake can be saved by revamping the Framework for Revival and Rehabilitation to restructure distressed accounts.

 

Bringing the PM internship scheme to MSMEs will help both employers and the additional hands they employ. However, the most serious hurdles for the growth of MSMEs are access to affordable finance and the broader market. The solution lies in creating digital collaterals and asking banks to use them. The Budget should support digital infrastructure for MSMEs by linking the Unified Lending Interface (ULI) — the RBI’s digital platform to facilitate lenders' decision-making — with other digital platforms, such as Aadhaar-linked KYC, E-Udyam, TreDS, GST data, income tax, and the Open Network for Digital Commerce (ONDC).

 

The ONDC can make MSMEs easily discoverable without relying on costly platforms like Amazon and Flipkart. Its usage should be encouraged through tax rebates and subsidies for ONDC-compliant software and hardware. AI-powered Big Data analytics can consolidate financial data from this and other platforms, along with bank statements, to create an accurate financial profile that can be used by banks to finance MSMEs.

 

Through these measures, the Budget will generate employment, boost income levels, and bolster the efficacy of growth-supportive monetary policy.

 

The author is director, Delhi School of Economics, and member, monetary policy committee. The views are personal