Context

There has been an uproar about the working papers of the IMF and World Bank, reporting no or low poverty for India in the pandemic year or just before that.

About the IMF paper

• The paper by Roy and Weide (2022) for the World Bank explores the possibility of using CMIE (unemployment data) in poverty calculations after correcting for the unrepresentative character of its panel data by modifying the weightages of households for aggregation.
• These adjustments carried out to remove the non-convergence of the CMIE data with other macro statistics have resulted in a poverty figure of 12 per cent.

What does the poverty index measure or attempt to capture?

• Its construction involves complex calculations — to identify a poverty basket of consumption, working out price indices for updation of the poverty line and then applying it to the income or consumption of households for determining their poverty status.
• Absence of consumption expenditure: The computation becomes far more challenging in the absence of data on consumption expenditure as is the case in India and several developing countries.
• Intending to provide inputs for policy making, researchers have evolved ingenious methods of estimating the data, using past datasets and those that have not been designed to get robust expenditure estimates.

Background of poverty line in India

• A nine-member working group set up by the Planning Commission proposed the poverty line at Rs 20 per capita per month in the early Sixties, loosely ensuring the adequacy of minimum requirements.
• Poverty line based on calorie needs: Dandekar and Rath (1970) went into detail about minimum calorie needs, based on the average consumption pattern.
• Issues with calorie based poverty line: During the Eighties and Nineties, it was realised that this linkage is getting blurred due to changes in the consumption pattern, microenvironment for living, etc.
• Sukhatme argued that the emphasis on calories and nutrition is misplaced as the absorption of nutrients depends on physical health, particularly the presence or absence of gastrointestinal diseases.
• Water and sanitation facilities were noted as important in determining the poverty line.
•  It was accepted that the state, through poverty interventions, cannot and should not try to guarantee adequate nutrition to people.
• Delinking the nutritional norms: The Tendulkar Committee formally announced delinking of nutritional norms from poverty in 2010.

Extrapolating the consumption expenditure on NSS 2011-12

• Bhalla, Virmani and Bhasin (2022) in their IMF Working Paper have developed a method of interpolation and extrapolation of the consumption expenditure of the NSS 2011-12 and building a series up to 2019-20.
• They use the growth rate of private final consumption expenditure (PFCE) but bring in the distributional changes by allowing household consumption to grow as per the nominal per capita income in each state.
• Takes into account rural-urban price difference: Rural-urban price differences are also introduced through separate poverty lines.
• The method is reasonable except that it assumes the distributions to remain unchanged both within the rural and urban segments in each state over 2014-20.
• Also, the growth rates of different commodities in the PFCE are significantly different and hence commodity-wise adjustments can be done to give higher weights to the items of consumption by the poor.
• Taking into account the role of state: The most significant contribution of the study is its bringing in the differential engagement of the state in the provisioning of the essentials to the poor into poverty calculations.
• This opens up the possibility of changes in the level of state engagement in poverty estimation, including free gas cylinders, etc.

Conclusion

People find the World Bank paper figures pegged at 12% more acceptable not because of the methodology but the magnitude. One does not know whether the poverty estimate would be a bit higher had the adjustments been carried out for a few other parameters and also at the state level.

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Context

The Indian economy has been hit by inflationary shocks of late.

Inflation story so far

• RBI mandate: The inflation target of the Reserve Bank of India is 4 per cent, with a band of 2 per cent on either side.
• Inflation was at or above the upper threshold of 6 per cent since the beginning of this year.
• Only after inflation hit 7 per cent did the RBI raise the repo rate.
• Increase in interest rate: The RBI has raised the cost of borrowing (by 90 basis points so far), with a promise of more to come.
• Fuel taxes reduced: The central government has cut fuel taxes with alacrity, and has banned the export of certain items.

Role of monetary authorities

• Monetary authorities raise interest rates if inflation is above the preferred target, and vice versa.
• What should be the interest rate? Interest rates should rise more than inflation so the “real” interest rates rise, causing a compression in demand (and a fall in economic activity), which in turn will reduce inflation.
• The RBI embraced this idea. In 2016, an independent monetary policy committee was constituted.

Effects of global inflation

• Some part of inflation is coming from abroad is an added complication.
• Outflow of fund: There has also been a steady outflow of foreign funds from the stock market.
• Depreciation of rupee: This could cause the rupee to depreciate, in turn, raising the prices of imported goods thereby adding to the inflationary woes.

Two ways in which the Indian economy is different

1] Role of agriculture in Indian economy

• India’s non-food and non-oil components of the consumer price index CPI are about 47 per cent.
•  In comparison, for the ECB, it is less than one-third of the CPI.
• Of course, the RBI has no control over international prices of food and oil, so it must squeeze less than 50 per cent of the domestic economy to lower inflation.
• The real interest rise works through demand compression.
• But the problem is on the supply side.
• Also, as compared to the RBI, the ECB would suffer a lower rise in inflation, and has a larger menu on which to apply demand compression.

2] Exchange rate and its effect on output

• Until the 1970s, the accepted wisdom was that an economy had to achieve both internal balance and external balance.
• Internal balance consisted of full employment and low inflation using monetary and fiscal policies.
• Over time, the internal balance has come to mean, from a policy perspective, low inflation, since “the market” will ensure full employment.
• External balance required a balanced current account over some horizon (“don’t get too much into foreign debt”), by using, for example, the exchange rate.
• For the OECD countries, the external balance was not a constraint any longer, since they had made their currencies fully convertible, and international capital flows were unrestricted.
• But this is not the case with India.
• If it were so, no one would be interested in discussing the country’s foreign exchange reserves, because these could be generated instantaneously by exchanging the domestic currency for foreign exchange.

India’s foreign reserves and its impact on competitiveness of Indian products

• Until 2020, India had seen massive portfolio capital inflows when OECD interest rates were low, and its current account deficits were financed by foreign reserves.
• But portfolio inflows can, and do, reverse themselves.
• FII inflows also contribute to India’s lack of competitiveness.
• The RBI bought foreign exchange (with rupees).
• But fearing this would stoke inflation, it sold government bonds, and removed the excess liquidity.
• This “sterilised intervention” saw the RBI’s foreign exchange assets going up, matched by a reduced holding of government bonds.
• Thus, India’s foreign exchange reserves were not its “own”— there were liabilities against it.
• India’s Dutch Disease: The RBI could have let the rupee appreciate or have accumulated foreign reserves.
• It chose an intermediate solution — a mix of an appreciation and accumulation of reserves.
• The appreciation caused by inflows reduced international competitiveness for Indian products.
• In effect, we had our own episode of the “Dutch Disease”.

Way forward

• As the RBI raises interest rates, outflows will possibly slow down with the rupee appreciating.
• That is not good for external balance.
•  It is easy to see that inflation targeting could be at odds with external balance.

Conclusion

If inflation does prove stubborn, and fighting inflation is all that the authorities in India worry about, we could see an external crisis.

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Back2Basics: What is Dutch Disease?

• Dutch disease is an economic term for the negative consequences that can arise from a spike in the value of a nation’s currency.
• It is primarily associated with the new discovery or exploitation of a valuable natural resource and the unexpected repercussions that such a discovery can have on the overall economy of a nation.
• Symptoms include a rising currency value leading to a drop in exports and a loss of jobs to other countries.

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