Opinion Killing growth to wound inflation
The back of inflation is already broken. What data is the RBI looking at?
This week saw two major economic releases by the government of India the index of industrial production and the wholesale price index. On October 25,the RBI will announce its decision on whether it will continue to hike interest rates,or take a break from the fast running that it has been doing for the last 500 basis points.
The economic,analyst,journalist and policy communities are deeply divided on whether the RBI should pause,or continue to hike. The arguments of the latter are,without much risk of exaggeration or imprecision,broadly as follows: At 9.7 per cent,headline WPI inflation is still very high. Until this has clearly come down,the RBI would be stupid to take its foot off the repo accelerator. There is almost a perfect correlation between the advocates of this view and their allegiance to very old-fashioned monetarism that is,inflation is always a monetary phenomenon,whether in 1611 or in 2011.
The pausers belong to a more recent globalisation/open-economy vintage. Their belief is that there are two kinds of inflation that determined by the supply side and that determined by excess demand. Supply-side inflation is generally the kind over which a central bank is not expected to have much control. It is inflation caused by demand-inelastic important consumption items not subject to market forces the world price of oil,or the price of food.
Normally,food prices do not affect inflation in most countries,because in most countries,food is a freely traded item. But not in a country like India,where agriculture is the most (politically) controlled sector. Even in the worst of our licence-raj existence,the industrial sector in India was relatively freer than todays UPA-led agricultural sector. (Dr Manmohan Singh,Indias economic reform innovator,where art thou?)
Coming back to the birds. The doves make three points. First,they say that a fair amount of inflation in India has,in the last four years,been of the supply-side variety. They note the large role played by the political operation of agricultural procurement prices in generating inflation in India. (Immodestly,Oxus will claim credit for first highlighting the issue a now de rigueur mention by most analysts and experts. Thank you.) The relative price (the excess of procurement prices over non-agricultural prices) increased by a shocking 20 per cent between 2007 and 2009,election year. This vote-grab policy made a large contribution to overall inflation since food is almost 50 per cent of the index for consumer prices.
The second dove-like point is that inflation that can be affected by monetary policy is already low. The third bird-to-bird point is a plea to the hawks in Mumbai and Delhi to please look at what is happening to economic growth,both domestic and international. Such growth has collapsed and is expected to stay low for some time.
The old-fashioned monetarists take considerable pride in rejecting all notions of growth entering into their thinking they are the true black-and-white conservatives. No shades of grey,or doubt. If there is inflation,it is only because money supply growth is too high. How do we know that money supply growth is too high? Because inflation is high. How do we know it is too low? Because inflation is too low. Such crude monetarism is today discarded by even the less crude monetarists. In response,the old-fashioned types have shifted ground ever so slightly and now state: excess inflation is caused by interest rates that are too low. How do we know there is excess inflation? Because rates are too low. How do we know…
Some readers might think I am exaggerating. I most emphatically am not. The views reported above are representative of the views contained in some major investment bank reports,and in the opinion pages of leading newspapers. It goes without saying that such views are only to be found in India,the Unique.
There has been much talk by the experts that India was behind the curve in tightening. By behind the curve I mean that the RBI was too slow in raising rates. But the curve is not a one-way street. You can be (and the RBI is) behind the curve by raising rates too much.
A new RBI (monetarist?) offering we cannot pause,let alone reduce rates,until inflation is brought under control. Without going into the matter of whether the RBI is looking at the proper indicator of underlying inflation (ongoing inflation vs rear window year-on-year inflation),there is the small matter of logic,and practice. If the RBI reduces rates after inflation has been brought down,then where is leadership? Where is policy? Isnt reducing rates after inflation has been reduced a bit like stating I will only buy stocks after they have peaked?
Issues of ideology cannot be settled by logic but there is a chance of settling them by evidence. Look at the attached chart,which plots inflation in 2011 versus inflation in the initial high-inflation year,2008. (The data are seasonally adjusted but the seasonal factors are the same for 2008 and 2011.) Note that in March 2011,the WPI index was at 104.5; the number released today for September 2011 is at 106.3. That is an inflation of 1.7 per cent over six months,or 3.4 per cent at an annualised rate. Manufacturing inflation is at an annual rate of 1.4 per cent.
So a special question for the old-fashioned monetarists practicing rear-window statistics. The RBI should raise rates when inflation for half of the fiscal year is at a 3.4 per cent annual rate? And industrial growth for the first half of the fiscal year is at an annual 2 per cent rate? Someone has got the picture radically wrong and the evidence suggests it is not the doves,or me.
The writer is chairman of Oxus Investments,an emerging market advisory and fund management firm
Share
