Inflationary Pressure On Budget

 

Umesh Thapa

 

The government presented a highly ambitious budget, which envisages spending Rs. 1048.92 billion over the next year. This is substantially higher than the current year’s budget, which is Rs. 819 billion. There are worries that the budget tabled by the government is likely to spur inflation.

Inflation can be defined as a persistent and appreciable increase in the general price level of goods and services in an economy over a period of time. It is measured every year by a number called the Consumer Price Index (CPI). The government has targeted to tame the inflation at 7.5 per cent while achieving an economic growth rate of 6.5 per cent. The average inflation rate in the current fiscal year 2015/16 is estimated to be 9.5 per cent.

 

Checking inflation

Inflation up to a certain level is advantageous and desirable as it is conducive to economic growth and employment. A moderate rate of inflation keeps the economic outlook optimistic, promotes economic activity and prevents economic stagnation. But beyond this level, inflation is harmful and often proves disastrous to the economy. Therefore, when the inflation rate crosses this desirable limit, it has to be controlled. Besides, inflation creates many social and political problems. So the government has announced it would check the inflation at 7.5 per cent, given the expansionary nature of the budget and the goal of achieving higher economic growth.

If inflation is rapid, people will begin hoarding out of fear of a price increase. Basically, a rupee has less buying power every year. This leads to lower savings and investments. Sometimes, it can lead to social unrest and revolt. It interferes with the regular working of the economy.

The salary increment of the government staff by a whopping 25 per cent has become a major concern of many, which they fear will give rise to a further hike in inflation. The budget which has allocated a significant portion of the resources for the Constituency Development Fund is also going to drive up inflation. Similarly, the current budget has substantially increased various allowances accorded to different sections of the population: the elderly, single women and members of marginalised groups.

The budget for FY16-17 has raised the income tax exemption limit to Rs. 350,000 from the current Rs. 200,000. As per the budget, individuals who earn less or equal to Rs. 350,000 and couples who earn less than Rs. 400,000 do not have to pay income tax. This relaxing tax base will influence the buying power of people and increase the size of disposable income.

Increase in aggregate demand comes from increase in incomes and increase in money supply. Insufficient supply in an economy or increase in the cost of production leads to cost push inflation. There is already abundant liquidity in the banks, but it has not been utilised, so creating a business-friendly environment is a must to revive the economy.

Excess liquidity is an outcome of monetary weakness, which shows serious impediments in the economy. The excess liquidity in the banking system also reflects the inability of the economy’s inadequate infrastructure to absorb spending, and the only remedy is heavy investment in public sector projects. These circumstances lead to lowering of the interest rate, which leads to capital flight.

The huge capital spending can also exert inflationary pressure over the economy, particularly through deficit financing. Demand generated by money supply or government expenditure exceeds the level of output. Hence, it is necessary to utilise such borrowings in productive sectors of the economy to give back in higher volume at a faster rate and with higher productivity. This helps to improve the supply level and match the demand.

Since the monetary policy is a demand management policy, it deals with the volume of money supply, and such a policy seems usually targeting inflation as the core objective. So a monetary policy formulated by the central bank always aims at keeping inflation within the desired level. In particular, the fiscal policy should work in tandem with the monetary policy in order to achieve the targeted objective. Thus, to tame inflation, it is necessary to implement an updated monetary policy in harmony with the fiscal policy.

 

Bleak scenario

The Economic Survey of FY 15/16 painted a bleak economic scenario of the country. GDP growth at basic price is 0.77 per cent in the current fiscal year, which was 2.32 per cent in the last FY 14/15. Inflation continued to remain on the higher side, affecting the overall savings of the people, although the government has announced some measures to address the supply constraint, which is largely responsible for the spike in inflation.

The rise in inflation in Nepal is mainly due to constraints/disruption in the supply system. So the price situation in Nepal tends to be affected more by structural and external factors. The increasing energy crisis, load shedding and blockade affected the supply side arrangements. If the government can crack down on the cartels responsible for the price hikes, the central bank can tame the demand-fueled inflation through its monetary instruments. The central bank is obligated to bring a monetary policy to support the implementation of the budget.

 

 

 

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