Examine how the government has responded to the inflationary effect of rising global commodity prices by analyzing the effectiveness and durability of fiscal policy initiatives like lowering gasoline excise taxes and offering subsidies.
Model Answer The Reserve Bank of India (RBI) has frequently used interest rates as a tool to manage inflation, but relying solely on this method raises certain concerns for the Indian economy. 1. Higher Borrowing Costs When the RBI increases interest rates, borrowing costs for businesses, consumers,Read more
Model Answer
The Reserve Bank of India (RBI) has frequently used interest rates as a tool to manage inflation, but relying solely on this method raises certain concerns for the Indian economy.
1. Higher Borrowing Costs
When the RBI increases interest rates, borrowing costs for businesses, consumers, and the government also rise. For example, between May 2022 and March 2023, housing loan interest rates increased from 6.5% to 9%. This leads to reduced profitability for businesses, lowers consumer affordability, and strains government budgets.
2. Slower Economic Growth
Higher interest rates can discourage investment as businesses face higher borrowing costs. This may lead companies to delay or scale back investment plans, slowing economic growth and job creation. According to the OECD, this could decelerate India’s economic growth in FY24.
3. Impact on Exports
Raising interest rates can attract foreign capital inflows, causing the Indian Rupee to appreciate. While this may seem positive, a stronger Rupee makes Indian exports more expensive for foreign buyers, which can reduce demand for exported goods.
4. Reduced Household Consumption
As interest rates rise, individuals face higher costs on loans, leaving less disposable income for other spending. This reduction in household consumption can depress overall demand in the economy.
Broader Measures to Control Inflation
To address inflation without overly relying on interest rates, a more holistic approach is needed. These measures include:
- Fiscal Restraint: Reducing government spending and tightening fiscal policy can help control inflation without aggressive rate hikes.
- Taxation Reforms: Bringing essential inflation-inducing commodities like petroleum under the GST regime could help lower costs.
- Productivity Enhancement: Investing in infrastructure and technology can improve productivity, reduce costs, and help combat inflation in the long term.
In conclusion, while interest rates are a useful tool, they should be part of a broader strategy to manage inflation while supporting economic and employment growth.
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Government's Use of Fiscal Policy Tools to Address Inflationary Impact The government employs various fiscal policy tools, such as reducing excise duties on fuel and providing subsidies, to mitigate the inflationary effects of increasing global commodity prices. Reduction of Excise Duties on Fuel: ORead more
Government’s Use of Fiscal Policy Tools to Address Inflationary Impact
The government employs various fiscal policy tools, such as reducing excise duties on fuel and providing subsidies, to mitigate the inflationary effects of increasing global commodity prices.
Reduction of Excise Duties on Fuel:
One of the key measures adopted by the government to counter the inflationary impact of rising global commodity prices is the reduction of excise duties on fuel. Lowering excise duties on petrol and diesel can help in curbing the direct impact of high fuel prices on inflation, as fuel costs affect transportation and production costs across various sectors.
Provision of Subsidies:
Additionally, the government provides subsidies in various forms to stabilize prices and shield consumers from the full impact of rising commodity prices. Subsidies on essential commodities like food items can help in controlling inflation by keeping prices in check for consumers.
Assessment of Sustainability and Efficacy
Sustainability of Measures:
While reductions in excise duties and the provision of subsidies can provide short-term relief from inflationary pressures, their sustainability over the long term can be challenging. Heavy reliance on subsidies can strain government finances and may not be a sustainable solution in the face of prolonged commodity price hikes.
Efficacy of Measures:
The efficacy of these fiscal policy tools in addressing inflationary impacts depends on various factors. While reducing excise duties on fuel can help in easing immediate price pressures, the extent to which these reductions are passed on to consumers by oil marketing companies also plays a crucial role in determining their effectiveness.
Recent Examples:
In recent years, the Indian government has utilized these fiscal policy tools to address the inflationary impact of rising global commodity prices. For instance, during periods of sharp increases in fuel prices, the government has occasionally announced excise duty cuts to provide relief to consumers. Similarly, subsidies on essential commodities have been used to stabilize prices and protect vulnerable sections of society from the impact of inflation.
Conclusion:
See lessIn conclusion, while the government’s use of fiscal policy tools like reducing excise duties on fuel and providing subsidies can be effective in managing inflationary pressures in the short term, their sustainability and long-term efficacy need to be carefully evaluated. A balanced approach that considers the broader economic implications and fiscal sustainability is essential to ensure that these measures effectively mitigate the impact of rising global commodity prices on inflation while supporting overall economic stability.