How durable is the economic recovery?
The recovery in investment and consumption is expected to continue as reflected in the momentum of high frequency indicators. The pick-up in vaccinations should also support a further normalisation in activities. At the same time, there are both downside and upside risks to economic outlook.
Taxes on fuel have emerged as a key issue which is seen fuelling inflation. Should the government cut taxes?
Fuel taxes implemented at the central and state levels became an important source of revenue for the government during the pandemic and helped create much-needed fiscal space to provide support to vulnerable households and increase spending in priority areas like healthcare. Our recommendation is to maintain the existing taxes on fuel, while at the same time increase direct support to low-income households. Reducing fuel taxes in general disproportionately benefits higher-income households, making such policies highly regressive.
The IMF official’s contention may be true elsewhere. But in India, with its large number of two-wheeler users, it would be inaccurate to say that fuel consumers belong only or even largely to high income groups. The high taxes on fuel thus hurt the lower middle class too. Given this situation, the government should roll back some of the tax hikes from recent years.
How much of worry is the inflation situation?
Despite recent moderation, inflation pressures persist, including sticky core inflation and pandemic-related supply disruptions. Given the negative output gap, an accommodative monetary stance, coupled with adequate systemic liquidity through various instruments, while closely monitoring elevated inflation pressures as conveyed, remains appropriate. Although the near-term inflation outlook is likely to be driven by lower food prices and base effects, inflationary pressures need to be closely monitored, given strengthening demand, rising commodity prices and higher inputs prices.