At less than 3%, the inflation figure for May is well within the target set by the government of India. This has led to a celebration in the media of the Reserve Bank of India’s prowess in macroeconomic management, of which inflation control is an important part. What has received next to no acknowledgement, though, is that in the same month, unemployment had risen. Thus, while year-on-year inflation fell from 3.2% in April to 2.8% in May, the latest Periodic Labour Force Survey shows that the unemployment rate rose from 5.1% in April to 5.8% in May.
For those currently employed, as most commentators on the economy are likely to be, a reduction in inflation is good news, to the extent that their purchasing power is now being eroded at a lower rate. But for those seeking employment, it makes no difference. They remain unemployed.
A branch of economic theory dominant in the United States asserts that the unemployed have chosen not to work, as the market mechanism enables everyone who wishes to work to find employment. One needs only to visit the town centre in semi-urban areas to find migrant labourers milling around at mid-day to conclude that this would be a preposterous claim to make for India.
So, the first thing to note is that to monitor inflation while neglecting unemployment altogether, as the pundits do, is not a credible way of assessing the state of an economy. While missing the higher unemployment rate in May may be overlooked, as it is not part of the discourse on India’s economy today, it is surprising that the considerable reduction in growth has not received as much attention, when growth has been the centrepiece of the government’s pronouncements on the economy this past decade. The figures are as follows. GDP growth slid from 9.2% during 2023-24 to 6.5% in 2024-25. The observed rise in unemployment is consistent with this decline in growth.
The recently released provisional estimates of GDP by the National Statistics Office show the decline in growth to be spread across three quarters of the economy. Apart from Public Administration, for which the growth rate held, every other sector slowed in 2024-25. Agriculture alone grew faster, and much faster too. This development provides the clue to the decline in inflation. In 2024-25, the relative rates of growth of the agricultural and non-agricultural sectors would have led to a reduction of the supply-demand gap for agricultural goods, particularly food, in turn contributing to a lowering of the inflation rate. This is evident in the sharp deceleration in food-price inflation from the peak of close to 11% in October 2024 to less than 1% in May 2025.
Monetary policy, which is the RBI’s means for inflation control, could not have achieved the observed configuration of events. It would be difficult to maintain that an increase in the repo rate of just over 10% in June 2022, which has not been exceeded since, could have triggered so great a reduction in food inflation from late 2024. It is equally difficult to imagine that it could have brought about so widespread a slowing of the economy in 2024-25, especially of services, a large segment of which is unlikely to be dependent upon formal credit. On the other hand, the impact of a narrowing difference in the rates of growth of the agricultural and non-agricultural sectors of the economy, as witnessed, can have a direct impact on the inflation rate. The reduction in food-price inflation impacts inflation directly, as food prices are part of the consumer price index, and indirectly via rising wages, which feed into the price of non-agricultural goods.
Econometric evidence
We have so far evaluated the role of monetary policy in relation to events. The economics profession usually settles empirical issues via econometrics—the application of statistical methods to economic models. This leaves little in doubt as to the inefficacy of monetary policy for inflation management. In our article “Inflation in India: Dynamics, distributional impact and policy implication” (‘Structural change and Economic Dynamics’, June 2025), we demonstrate that there is no conclusive evidence of the role of the interest rate in controlling inflation in India.
On the other hand, there is conclusive econometric evidence of the overwhelming role of the price of agricultural goods, driven by the relative rates of growth of the agricultural and non-agricultural sectors. Inflationary pressure generated by such a mechanism requires augmenting supply to be controlled. Inflation targeting, which works via contraction of demand, is not a solution. If, in the face of a persistent excess demand for agricultural goods, inflation is lowered by hiking the interest rate in order to restrain demand, other things remaining the same, inflation will rise when next the interest rate is lowered and growth revives.
Two final observations should seal the debate on the role of the RBI in lowering the inflation rate today. First, an allegedly sophisticated view of ‘inflation targeting’, the model of inflation control adopted by the RBI, holds that a central bank can actually control inflation by influencing expectations of economic agents. When we study the RBI’s own data on the expectation of inflation by households, we find that it has remained almost unchanged from March 2024 to May 2025, and has been far higher than the RBI’s target inflation rate of 4%. Therefore, the recent decline in inflation could not have been engineered by inflation targeting.
Secondly, after the last meeting of the Monetary Policy Committee, the RBI Governor expressed willingness to lower the repo rate further if inflation continues to decline. Given evidence of the ineffectiveness of the repo rate in controlling inflation, such a policy stance would imply that monetary policy in India merely follows inflation rather than directing its course.
Pulapre Balakrishnan is Honorary Visiting Professor and M. Parameswaran is Professor, Centre for Development Studies, Thiruvananthapuram
Published – June 24, 2025 01:55 am IST