There is almost a formula to it.
A few days before the Reserve Bank of India(RBI) is supposed to meet to review the monetary policy, business lobbies and industrialists start coming out with statements demanding that the RBI cut the repo rate. Repo rate is the interest rate at which RBI lends to banks and sets the benchmark for the interest rates at which banks in turn lend to businesses and consumers.
This time was no different. “We hope for a 50 basis points cut in the repo rate as retail inflation has started receding,”Confederation of Indian Industries (CII) Director General Chandrajit Banerjee had said on March 30, 2014.
Rana Kapoor, president, Associated Chambers of Commerce and Industry of India (Assocham), echoed the same sentiment when he said that the RBI should cut the repo rate by 50 basis points. One basis point is one hundredth of a percentage.
But the RBI did not oblige the lobbies this time as well. In it’s first First Bi-monthly Monetary Policy Statement, 2014-15, the central bank decided to keep the repo rate at 8%. This, despite the fact that inflation as measured by the consumer price index(CPI) has been on its way down.
In February 2014, CPI inflation was at 8.1%. This after it had touched 11.24% in November 2013. A major reason for the fall has been a fall in food prices. As RBI governor Raghuram Rajan had said in speech on February 26, 204 “inflation measured by the new CPI has remained in double digits during April 2012 to January 2014, averaging 10 per cent over this period. Food inflation, which has a weight of 47.6 per cent in the index, has contributed the largest share of headline inflation. Food inflation itself has stayed in double digits throughout this period, edging down to 9.9 per cent only in January 2014.” In February 2014, food prices rose by 8.57% in comparison to last year.
Has the risk of food prices rising at a much faster rate gone away? Not really. Unseasonal rains and hailstorms in parts of the country have damaged crops, and this is likely to push up prices again. The RBI also thinks that the fall in food prices may be temporary. “Retail inflation measured by the consumer price index (CPI) moderated for the third month in succession in February 2014, driven lower by the sharp disinflation in food prices, although prices of fruits, milk and products have started to firm up,”the RBI statement said.
It also feels that vegetable prices may not fall any further. “Since December 2013, the sharper than expected disinflation in vegetable prices has enabled a sizable fall in headline inflation. Looking ahead, vegetable prices have entered their seasonal trough and further softening is unlikely,” the RBI statement said.
The central bank also feels that there are “risks…stemming from a less-than-normal monsoon due to possible el nino effects.” Even this could drive up food prices.
Having said that, what is the link between interest rates and food prices? Prima facie there does not seem to be any link. But Rajan explained a link in his February speech. As he said “There has been an increase in liquidity flowing to the agricultural sector, both from land sales, as well as from a rise in agricultural credit. More loans to agriculture have fostered substantial private investment in agriculture, but may also have pushed up rural wages.” This in turn has played a part in pushing up food prices in particular and overall prices in general. And hence it is important to maintain high interest rates.
Rajan had also said that “monetary policy is an appropriate tool with which to limit the rise in wages, especially urban ones. The slowdown in rural wage growth may be partly the consequence of tighter policy limiting wage rise elsewhere.”
Also, non fuel- non food inflation, which constitutes around 40% of the consumer price index continues to remain high. “Excluding food and fuel, however, retail inflation remained sticky at around 8 per cent. This suggests that some demand pressures are still at play,” the RBI statement said. This number has barely budged for a while now. Non fuel-non food inflation takes into account housing, medical care, education, transportation, recreation etc. And this is a major reason why the RBI does not seem to be in any mood to cut the interest rate.
Business lobbies need to understand a basic point here. India’s retail inflation continues to remain high despite a collapse in investment. As Chetan Ahya and Upasna Chachra or Morgan Stanley write in a recent research report titled Five Key Reforms to Fix India’s Growth Problem and dated March 24, 2014, “Public and private investment fell from the peak of 26.2% of GDP in F2008 to 17.3% in F2013. Indeed, private investment CAGR[compounded annual growth rate] was just 1.4% between F2008 to F2013 vs. 43% in the preceding five years.”
Now imagine what would happen if investments were to pick up a little? Inflation instead of coming down would have gone up for sure, creating further economic problems. As economist Rajiv Malik of CLSA writes in a column in the Business Standard today “In fact, it is more than likely that if the investment had not weakened as much as it needed to – or if it had recovered sooner or more strongly than has been the case – India’s macroeconomic imbalances, including elevated inflation, would have been much worse.”
If India’s economic growth has to come back on track, the inflation monster needs to be killed first. And given that RBI and Rajan are on the right track.
The article appeared on www.FirstBiz.com on April 1, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)