In a note out today, Morgan Stanley’s Chetan Ahya pegs the real cause of inflation in India, and it’s not the Fed or even extreme weather. Instead it has to do with fiscal expansion outpacing actual investment.
As we have been highlighting, both loose fiscal and monetary policy have played a role in boosting
growth at the cost of rise in macro imbalances. Of those imbalances, inflation still concerns us the most. At the heart of the inflation problem in India is, we believe, the loose fiscal policy that is being pursued by the government for much longer than needed. The genesis of the inflation problem is a rise of close to 4% of GDP in government expenditure (largely boosting consumption) at a time when credit crises pulled down private corporate capex (read, capacity creation) by a full 5.8% points. Even withut a quick support from policy rates, aggressive market-driven bank deposit rate hikes have meant that the effective monetary tightening is done. We believe now a reduction in government expenditure relative to GDP will be most critical to address the inflation pressures in a fully secure manner.
In other words, too much artificial stimulation of demand has lead to a reverse output gap of sorts.
Photo: Morgan Stanley
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