RBI Governor Raghuram Rajan presided over his last monetary policy meeting on August 9. He demits office on September 5, three years after he assumed control over India’s monetary policy. There will be, and there should be, several articles examining his performance as RBI governor. This is my first.
In this first evaluation I will examine his performance in stabilising India’s macro-economy. Possibly the most important function of any monetary authority is control over inflation; so critical a function that India has legally adopted the system of inflation targeting. In the future, if inflation deviates from the target, the RBI will have to report to Parliament the reasons why it has missed the target, and what remedial policy it was adopting.
Inflation control had functioned very well without inflation targeting in India. It is now conveniently forgotten (especially by the UPA government) that rural inflation (represented by CPI for agricultural labourers) registered an annual rate of only 4.2 per cent between June 1996 and May 2004. The end-points represent the departure of the Congress-led government and the installation of three different non-Congress prime ministers. During the same time-period, urban inflation (represented by CPI for industrial workers) registered an average rate of 5.8 per cent. A simple average of the two yields a 5 per cent average inflation.
Then along came the UPA government and with them, the quest for 273 seats in parliament. What is the link? The belief that the rural vote could be bought via large increases in the minimum support prices for major crops like rice, wheat and sugar. Hence, in a time-period (June 2006 to May 2014) when median developing country inflation stayed constant at around 5 per cent, rural inflation galloped ahead to an average of 8.6 per cent per annum, and urban inflation at 8.2 per cent.
In September 2013, CPI inflation (hereafter the inflation figures refer to the joint urban and rural CPI series) was 10.5 per cent and Rajan had a Volckeresque task ahead of him, that is, how to eliminate generalised inflation from the system and bring the system back to the pre-UPA normal, that is, low overall inflation with occasional spikes in individual items like onions or pulses.
Median developing country inflation has declined from 5.1 per cent in 2013 to around 3.5 per cent at present. So the enabling international environment has been positive for declines in inflation. However, since September 2013, the price of imported crude oil dropped from Rs 6,700 a barrel to Rs 3,290 a barrel (as of June 2016); but, the Indian consumer hasn’t seen much of the decline. The CPI for petrol reduced from 112 to 95 — just a 17 per cent decline. Note that the price of pulses (with a near identical importance in the CPI as petrol) during this period increased from 106 to 174 — a 64 per cent increase. In other words, to point to the oil price decline as a major, or even a minor contributor, to the CPI decline in India under Rajan is to make an error of mammoth UPA (or IMF?) proportions.
To be sure, international commodity prices have also weakened during Rajan’s tenure, but what has happened to commodity prices in India is currently being researched by me (and I am sure several others).
How well Rajan has done in reducing inflation in India is shown in Table 1 for seven categories of consumption. The reader (or policymaker) can choose her yardstick. Column 3 is the year-on-year (y-o-y) inflation in September 2013; column 4 is the y-o-y inflation in June 2016 (latest data available). Column 5 is the decline in per cent. For example — overall inflation in June 2016 was 5.7 per cent compared to the starting point of 10.5 per cent, that is, a decline of 45.7 per cent.
Summary of the results: No matter what the criteria, inflation has dropped, and dropped by a large magnitude between September 2013 and June 2016. Further, the decline is constant across the major groups and close to half the inflation level recorded in September 2013. Overall inflation almost halved, or a reduction from 10.5 to 5.7 per cent. There is a similar halving in the volatile category of fruit, pulses, and vegetables (FPV). What about food excluding FPV? Today, this “high inflation” category is inflating at just 4.9 per cent. Core inflation, or inflation excluding food and fuel? Just 4.5 per cent — a large reduction from 7.8 per cent in September 2013. Finally, I report an inflation number for 88.7 per cent of all goods in the CPI, that is, all goods minus the price inelastic and price volatile perishables, FPV. Somewhat surprisingly, this broadest measure of inflation reports a 4.5 per cent value — the same as the popular core index of inflation.
Thus, no matter how one looks at the figures, Rajan’s record in reducing inflation has been spectacular. To be sure, this reduction was possible because of the “beautiful friendship” (watch Casablanca) that evolved between the RBI (Rajan), the ministry of finance (Arun Jaitley) and Prime Minister Narendra Modi. It was a friendship that many thought was “permanent” and could not be brought down — except, tragically, by dirty politics.
But the inflation buck stops with Governor Rajan. While the government deserves some credit, the fact remains that this extraordinary inflation decline observed in India would not have been possible without Rajan’s leadership and his (correct) single-minded obsession with returning inflation to normal in India. As the table shows, even food excluding FPV has an inflation rate of only 4.5 per cent. FPV inflation is likely to decline post October, when the monsoon effects on perishable prices will begin to more than trickle in. If FPV inflation for a few months is zero (let alone negative), overall headline inflation will register 4 per cent, not the 5.7 per cent observed at present.
That will mean that inflation under Rajan is one-third the level he inherited, and one-third at a very respectable level of 4 per cent. The financial world had wondered whether it will ever see the likes of Volcker again — he reduced US CPI inflation from 13.5 per cent inflation in 1980 to 6.2 per cent in 1982 and 4.4 per cent in 1984. What did help Volcker enormously was the decline in the price of crude oil — 25 per cent from about $40 a barrel in May 1980 to about $ 30 a barrel some three to four years later. This luxury, as documented above, was not available to Rajan. The international oil price decline was taxed in India, a correct policy and one fully supported by Rajan.
Rajan will go back to the world of ideas having left the macro-economy in a very sound condition. Thank you Rajan — India will miss you, and your ideas.