Tag: Food inflation | Page 2

18 March, 2015

Are acche din for the Indian consumer about to start?

Vivek Kaul

Half of the expenditure of an average Indian family is on food. In case of the poor it is 60% (NSSO 2011). This proportion comes down as income levels go up. Nevertheless, if food prices go up, the pinch is fell by almost everybody except the upper middle class and the rich.
This has an impact on consumption given that incomes don’t always rise at the same pace as food prices and overall inflation. People then cut down on their expenditure on other things leading to a slowdown in consumption growth.
In 2012-2013 and 2013-2014, private consumption growth was at 4.9% per year. In comparison this had been at 8.4% in the preceding five years. This was primarily because both food inflation and inflation as measured by the consumer price index(CPI) were at greater than 10% levels. As people spent more money on things they consumed on a daily basis, the growth in expenditure on non-essentials slowed down.
As Crisil Research points in a research note titled A Rs 1.4 trillion consumption kicker looms: “Sales growth in air-conditioners, washing machines and refrigerators nosedived from 18-20% in fiscal 2010 to 3-4% in fiscal 2014. Passenger vehicle sales plummeted to an average 6.2% in fiscals 2013 and 2014 compared with 29% in fiscal 2011.” This clearly tells us that many people postponed the purchasing things that were not essential for everyday living.
Things have changed in the recent past. The consumer price inflation for the month of February 2015 stood at 5.4%, well below the double digit levels. Food prices remained flat during the course of the month in comparison to February 2014.
Over and above this, oil prices have also fallen big time in comparison to where they were last year. On March 18, 2014, the price of the Indian basket of crude oil was at $104.47 per barrel. On March 16, 2015, around a year later, the price of the Indian basket of crude oil was at $52.11 per barrel or 50% lower. The entire fall in price of oil has not been passed on to the end consumers. The government has increased the excise duty on petrol and diesel. Nonetheless, there has been some relief for the end consumer. The retail price has fallen by Rs 12.3 per litre for petrol and Rs 6.8 per litre for diesel, since April 2014.
Crisil Research expects lower food inflation and lower oil prices to do the trick in pushing up private consumer expenditure growth: “The fall in food inflation and lower fuel prices will together yield additional ‘savings’ (or increase in spending power) of Rs 1.4 trillion in fiscal 2016 compared with nearly Rs 509 billion in fiscal 2015. Savings on fuel expenses alone will be Rs 300 billion, while on food it will be more than thrice that at Rs 1.1 trillion.”
Another factor that should help is a fall in inflation expectations(or the expectations that consumers have of what future inflation is likely to be). In the inflation expectations survey released by the Reserve Bank of India(RBI) for September 2014, the inflation expectations over the next three months and one year were at 14.6 percent and 16 percent.
In the latest inflation expectations survey for December 2014, these numbers crashed to 8.3% and 8.9%. A belief among consumers that prices will not continue to go up at the same rate as they have in the past, is very important to get consumption going again. Hence, a fall in inflation expectations should help.
What will also get consumption going is the fact that increasing disposable income will help people to borrow more, given that their capacity to repay will go up. As Crisil Research points out: “The household sector in India is under-leveraged, with the household debt (from bank and formal non-bank sources) to GDP ratio at just 12% compared with close to 80% in United States. Household debt from commercial banks and non-banking financial companies was nearly Rs 14 trillion as of March 31, 2014, including housing and educational loans. This is just 22% of household consumption. Moreover, most of the debt was accumulated in the last decade and more than 60% was taken to buy houses. If we exclude these housing loans – which do not form a part of consumption — then the ratio falls to 8%.” What this means that there is a huge scope for the Indian consumer to borrow and spend.
All these reasons will essentially ensure that in the financial year starting next month, the Indian consumer will make a comeback with his shopping bags. Crisil Research expects private consumption to grow by 7.8% in 2015-2016. “An increase in purchasing power led by declining inflation and improvement in incomes will ensure a gradual but steady pick-up in consumption demand next fiscal. At the sectoral level, we expect passenger vehicles sales to grow by 9-11% in fiscal 2016, up from 3-5% growth in fiscal 2015. Similarly, household appliances sales are forecast higher – television sales at about 9% compared to a 0.3% decline in fiscal 2015, air conditioners at 15% compared to 9%, and refrigerator at 10% compared to 5%.”
What can spoil this upcoming party for the consumer? The recent unseasonal rains in the Northern states will push food prices up in the coming months. As economists Taimur Baig and Kaushik Das of Deutsche Bank Research point out in a recent research note: “Disinflation in food prices have ended and it is more likely than not to expect higher food prices from March onward, especially given the recent unseasonal rainfall, which may have impacted some crops.”
Despite this negative, it looks like acche din for the Indian consumer are about to start.

The column originally appeared on The Daily Reckoning on Mar 18,2015

17 November, 2014

Raghuram Rajan won’t cut interest rates even in Hindi

At a recent function, Raghuram Rajan, the governor of the Reserve Bank of India (RBI), spoke in Hindi. The joke going around in the social media after that was that even in Hindi, Dr Rajan refused to cut the repo rate. Repo rate is the interest rate at which the RBI lends to banks. Nevertheless, four pieces of data that came out last week, will increase the pressure on Rajan to cut the repo rate. These four pieces of data are as follows:

Inflation as measured by the consumer price index fell to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013.
Inflation as measured by wholesale price index fell to 1.77%. It was at 2.38 % in September 2014 and 7.24% in October 2013.
The index of industrial production, which is a measure of the industrial activity within the country, grew by 2.5% in September 2014, in comparison to September 2013. The IIP for August 2014 was only 0.4% higher in comparison to August 2013. Interestingly, some economists believe that this marginal recovery in the IIP will not hold for October 2014. The reason for this lies in the fact that indicators of industrial activity like car sales, bank loan growth etc., have slowed down in October 2014.
The bank loan growth for a period of one year ending October 31, 2014, stood at 11.2%. This had stood at 16.4%, for the period of one year ending November 1, 2013. The loan growth year to date stands at 4.6%. It was at 7.6% last year.

These four data points have got the Delhi based economic experts and industry lobbyists brushing up their economic theory again. “It is time that the RBI started to cut interest rates,” we are being told. Chandrajit Banerjee, the director general of the Confederation of Indian Industries, a business lobby said “This provides sufficient room to the RBI to review its prolonged pause in policy rates and move towards policy easing in its forthcoming monetary policy especially as investment and consumption demand are yet to show visible signs of a pick-up.” This was a sentiment echoed by A Didar Singh as well. Singh is the secretary general of Federation of Indian Chambers of Commerce and Industry (FICCI), which is another industry lobby. As he put it “The inflationary expectations are fairly tamed and we see no immediate upside risks with regard to prices. Given that, it is important to reiterate that demand remains subdued. The consumer durables segment reported negative growth for the fourth consecutive month in September. It is imperative that all levers are used to pep up demand.” The idea here is simple. If the RBI cuts the repo rate, banks will cut the interest rates they charge on their loans as well. If that were to happen, people would borrow and spend more, and businesses would borrow and invest more. And this will lead to faster economic growth. Economics 101. QED. Banerjee and Singh are not the only ones asking for an interest rate cut. Sometime back industrialist Anand Mahindra had said that “It might be time for the RBI to think of a rate cut…The need of the hour has changed and its time to start to look to support growth.” Sunil Mittal, chief of Bharti Airtel, also suggested the same when he told CNBC TV 18 that the finance minister Arun Jaitley “had spoken for the nation,” when had asked for an interest rate cut. In an interview to The Times of India in late October Jaitley had said “Currently, interest rates are a disincentive. Now that inflation seems to be stabilizing somewhat, the time seems to have come to moderate the interest rates.” While all this sounds good in theory, things are not as simple as the businessmen and the politicians are making it out to be. It is worth recounting here what Rajan had said in a speech in February 2014: “But what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.” And what about the politicians? Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve, he did not receive a single request from the US Congress urging the Fed to tighten money supply and thus not run an easy money policy. In simple English, what Greenspan means is that the American politicians always wanted lower interest rates. The Indians ones aren’t much different on that front. Nonetheless, the question is will lower interest rates help in reviving consumption and investment? Let’s tackle the issues one by one. Let’s say an individual wants to buy a car. He borrows Rs 4 lakh to be repaid over a period of five years at a rate of interest of 10.5%. The EMI on this works out to Rs 8,598. Let’s say the RBI cuts the interest rate and as a result the interest rate on the car loan falls to 10%. The EMI now works out to Rs 8,499 or around Rs 100 lower. Now will an individual go out and buy a car because the EMI is Rs 100 lower? Even if interest rates fall by 200 basis points (one basis point is one hundredth of a percentage) to 8.5%, the EMI will come down by only around Rs 400. For two wheeler and consumer durables loans, the differences are even smaller. Hence, suggesting that lower interest rates lead to higher consumption isn’t really correct. The real estate experts think that cutting interest rates will help revive the sector. The basic problem with the real estate sector is that prices have gone totally out of whack and a cut in interest rates is not going to have any significant impact. What about corporate investment? As Rajan had asked in his speech “Will a lower policy interest rate today give him more incentive to invest? We at the RBI think not…We don’t believe the primary factor holding back investment today is high interest rates.” So what is holding back investment? The answers are provided in a recent report titled “Will a rate cut spur investments?Not really“, brought out by Crisil Research. As the report points out “Investment growth, particularly private corporate investment, plummeted in the fiscals 2013 and 2014, despite low real interest rates. During this time, the policy rate in real terms – repo rate minus retail inflation – has been negative, and real lending rates averaged 2.4%. This is significantly lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years.” The accompanying chart makes for an interesting read.

After 6 years, real repro rate (adjusted for CPI inflation) turns positive

Source: RBI, Central Statistical Office, CRISIL Research Note: Nominal repo rate at the fiscal year-end minus average CPI inflaction , F= Forecast

As Crisil Research points out “During fiscals 2013 and 2014, when investment growth slumped to 0.3% per year, the real repo rate was still minus 2.1%, while the real lending rate was only +2.8%. Only in June 2014, for the first time in six years, did the real repo rate turned mildly positive.” So companies were borrowing and investing at higher “real” interest rates earlier but they are not doing that now. Why is that the case? This is primarily because the expected rate of return on investments has fallen “because of high policy uncertainty, slowing domestic and external demand, and rising input costs driven by persistently elevated inflation.” “The rate of return on investments – as proxied by return on assets (RoA) of around 10,000 non-financial companies as per CMIE Prowess database – have fallen sharply to 2.8% in fiscal 2013 and 2014 from 5.9% in the pre-crisis years,” Crisil Research points out. Moral of the story: Corporates invest when it is profitable to invest, and not simply because interest rates are low. Indeed, the other factors that are likely to revive investment are in the hands of the government and not RBI. Hence, a cut in interest rates is neither going to revive consumer demand nor corporate investments. Having said that, high food inflation has been a big factor behind high inflation. And the RBI really cannot control that. Also, food inflation has come down considerably in the recent past. So why not just cut interest rates? Rajan explained it very well in his February speech where he said “They say the real problem is food inflation, how do you expect to bring it down through the policy rate? The simple answer to such critics is that core CPI inflation, which excludes food and energy, has also been very high, reflecting the high inflation in services. Bringing that down is centrally within the RBI’s ambit.” Further, food prices might start rising again. The government has forecast that the output of kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon. To conclude, despite falling inflation, the inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) are on the higher side. As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year. And for inflationary expectations to come down, low inflation needs to stay for a considerable period of time. As Rajan said “A more important source of our influence today, therefore, is expectations. If people believe we are serious about inflation, and their expectations of inflation start coming down, inflation will also come down…Sooner or later, the public always understands what the central bank is doing, whether for the good or for the bad. And if the public starts expecting that inflation will stay low, the central bank can cut interest rates significantly, thus encouraging demand and growth.” If inflationary expectations are controlled only then will consumer demand revive and that in turn, will lead to revival of corporate investments as well. Given this, it would be surprising to see Rajan start cutting the repo rate any time soon. The article originally appeared on www.equitymaster.com on Nov 17, 2014

Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He has just finished writing a trilogy on the history of money and the financial crisis. The series is titled Easy Money. His writing has also appeared in The Times of India, Business Standard, Business Today, The Hindu and The Hindu Business Line.

19 June, 2014

Continuing a legacy? When Jaitley does a Chidambaram on food inflation

Complex problems do not have straightforward answers. But politicians need to come up with simple answers in order to explain things, especially if they happen to be lawyers.
In order to tackle the high food inflation finance minister Arun Jaitley has asked states to “crack down on hoarders”. The food inflation for the month of May 2014 was at 9.5%(as measured by the wholesale price index and 9.4% (as measured by the consumer price index). Over the last ten years food inflation has averaged at 8.1% and has even gone above 10% in recent times.
Jaitley’s response to tackle food inflation was similar to what P Chidambaram had said in December 2013. “There is also a need to deal wisely with harvesting and marketing and deal strictly with hoarding and profiteering,” the former finance minister had said.
So is India’s food inflation problem only because of hoarding? As mentioned at the beginning, complex problems do not have simple answers. And India’s food inflation is a really complex problem.
One of the biggest hoarders of food is the government of India. The Food Corporation of India (FCI) indicates its grain stock at the beginning of every month. As on June 1, 2014, the food grain stock stood at 74.8 million tonnes. This primarily included rice and wheat.
This stock is much more than what is required by the government to run its various subsidy programmes and also to maintain an emergency stock and strategic reserve requirements. In fact, the Commission for Agricultural Costs and Prices(CACP), a part of the ministry of agriculture, estimated in May 2013, that anywhere between 41-47 million tonnes, would be a comfortable level of buffer stocks.
In fact, the level of the stocks with FCI has gone up dramatically since May 2004, when the Congress led United Progressive Alliance (UPA) first came to power. At the beginning of June 2004, the stock of food grain had stood at 32.3 million tonnes. It has more than doubled since then.
With more and more food grains landing up in the godowns of the government it is not surprising that price of food grains has risen over the last few years. The price of rice has risen by 12.75% over the last one year. The rise in the price of wheat has been rather subdued at 3.64%. But around the same time last year, the price of rice had risen 12.37% over a one year period.
In order to control grain prices, in the short run the government needs to sell some of its hoard in the open market. And that is exactly what it plans to do. It plans to sell 50 lakh tonnes of rice in the open market at a price of Rs 8.3 per kg. More importantly the government needs to stop hoarding rice and wheat, and not buy more than what it requires.
Other than the price of rice, the price of milk, fruits and egg, fish and meat has also risen at rapid rates of 9.57%, 19.4% and 12.47%, respectively. As far as hoarding is concerned India does not have the supply chain infrastructure required to hoard these food products. In this case, the inflation is clearly a case of the demand outstripping supply.
In a recent report titled What a Waste Crisil Insight points out that “inflation in egg, fish and meat has consistently [been] at 10-15% since 2009. The story is similar for milk and milk products where inflation peaked above 15% in 2012.” Hence, inflation in these products is not a recent phenomenon and more than that it has nothing to do with hoarding.
Crisil Insight points out that “loose fiscal policy, rising demand for high-value food items and substantial increase in wages — especially rural wages, as a spillover [of] the rural employment guarantee scheme – have translated into higher demand for proteins. This has raised the prices of items such as milk and milk products, egg, fish and meat as supply falls short of demand. The production of milk and eggs has risen only 3-4% a year, compounded annually, during 2009-10 to 2012-13, while inflation in this category has risen 14-15%.” Hence, the only way to control inflation in this area is to encourage more production of milk, eggs, fish and meat, and that of course, needs a lot of effort and cannot happen overnight.
So that leaves us with vegetables. Vegetable prices on the whole have fallen by 0.97% over the last one year. But this aggregate hides the fact that potato prices have risen by 31.44% in the last one year. In this case, the hoarding argument can apply given that hoarding potato is far more easier than hoarding other vegetables or fruits or meat for that matter.
Interestingly, onion prices haven’t gone up in the last one year. They have fallen by 2.83% during the period. At the same time last year, onion prices had gone up by 94.28% over a period of one year. In order to stop anything along similar lines from happening again, the government has imposed a minimum export price of $300 per tonne for onions. In fact, the ministry of commerce has been asked to come up with a similar measure for potatoes as well.
Hopefully, all these measures should have some impact on the burgeoning food prices. To conclude, it is important to understand that food inflation is not just because of traders hoarding food products. Prices of different food products have risen due to different reasons over the last ten years. And these reasons need to be specifically addressed, if food prices are to be controlled.
The article was originally published on www.firstbiz.com on June 19,2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)

1 April, 2014

RBI and Rajan are on the right track: the inflation monster needs to be killed first

Vivek Kaul

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)

20 December, 2013

Will Rajan do a Volcker before 2014 Lok Sabha elections?

Vivek Kaul
People who follow the Reserve Bank of India(RBI) governor Raghuram Rajan were expecting him to raise the repo rate by 25 basis points(one basis point is one hundredth of a percentage) in the mid quarter monetary policy review announced on December 18, 2013. Repo rate is the rate at which RBI lends to banks.
But that did not happen. This led one journalist attending the press conference after the policy announcement, to quip “We were expecting a Volcker, we got a Yellen.” To this, governor Rajan replied “Why a Volcker or a Yellen, how about a Rajan?” (As reported in the Business Standard).
Rajan took over as the 23^rd governor of the RBI on September 4, 2013. Since then he has often been compared to the former Federal Reserve chairman Paul Volcker.
Volcker took over as the chairman of the Federal Reserve of United States in August 1979. This was an era when the United States had double digit inflation.
Interestingly, when Arthur Burns retired as the Chairman of the Federal Reserve in 1978, the inflation was at 9%. Jimmy Carter, the President of the United States, chose G William Miller, a lawyer from Oklahoma, as the chairman of the Federal Reserve.
Miller had no background in economics. As Neil Irwin writes in The Alchemists – Inside the Secret World of Central Bankers “Most significantly, Miller, fearful of a recession, refused to tighten the money supply to fight inflation. By the summer of 1979, with inflation at 10 percent, Carter had had enough. He “promoted” Miller to treasury secretary as a part of the cabinet shake-up, a job with less concrete authority. That left him with a vacancy in the Fed chairmanship.”
Carter picked up Paul Volcker as Miller’s replacement. Volcker at that point of time was the President of the Federal Reserve Bank of New York. Volcker had been a civil servant under four American presidents. “In his meeting with the president before the appointment, Volcker told Carter he was inclined to tighten the money supply to fight inflation. That’s what Carter was looking for – but he almost certainly didn’t understand just what he was getting,” writes Irwin.
In the year that Volcker took over consumer prices rose by 13%. The only way out of this high inflation was to raise interest rates and raise them rapidly. The trouble was that Jimmy Carter was fighting for a re-election in November 1980.
As Irwin writes “On an air force jet en route to an International Monetary Fund conference in Belgrade, Volcker explained his plans to Carter’s economic advisers. They didn’t like them one bit. Sure, Carter wanted lower inflation. But higher interest rates affect the economy with a lag of many months. There was barely a year to go until the president would be running for reelection, which meant that just as their boss was asking voters for another term, unemployment would be sky-rocketing due to the new Volcker policy.”
Volcker was not going to sit around doing nothing and came out all guns blazing to kill inflation which by March 1980 had touched a high of 15%. He kept increasing increasing rates, till they had touched 20% by January 1981. This had an impact on inflation and it fell to below 10% in May and June 1981^.
The prime lending rate or the rate at which banks lend to their best customers, had been greater than 20% for most of 1981^. Increasing interest rates did have a negative impact on economic growth and led to a recession. In 1982, the unemployment rate crossed 10%, the highest it had been since 1940 and nearly 12 million Americans lost their jobs.
During the course of the same year, nearly 66,000 companies filed for bankruptcy, the highest since the Great Depression. And between 1981-83,, the economy lost $570 billion of output. While all this was happening, Jimmy Carter also lost the 1980 presidential elections to Ronald Reagan.
India and Rajan are in a similar situation right now. The consumer price inflation(CPI) for the month of November 2013 was at 11.24%. In comparison the number was at 10.17% in October 2013. At the same time Lok Sabha elections are due next year.
In this scenario will Rajan jack up the repo rate to control inflation? When a central bank raises the interest rate the idea is to make borrowing expensive for everyone. At higher interest rates people are likely to borrow less than they were in the past. Also, people are likely to save more money. This ensures that a lesser amount of money chases goods and services, and that in turn brings inflation down.
At higher interest rates, borrowing becomes expensive for the government as well. This might force the government to cut down on its expenses. When a government cuts down on its expenses, a lower amount of money enters the economy, and that also helps in controlling inflation. But that is just one part of the argument.
One school of thought goes that there is not much the RBI can do about inflation by increasing interest rates. Leading this school is finance minister P Chidambaram. As he said in late November “Consumer inflation in India is entrenched due to high food and fuel prices and monetary policy has little impact in curbing these prices…There are no quick fixes for inflation, will take some time to fix it,” he said.
This logic is borne out to some extent if one looks at the inflation numbers in a little more detail. The food inflation as per wholesale price index(WPI) was at 19.93% in November 2013. Within it, onion prices rose by 190.3% and vegetable prices rose by 95.3%. The food inflation as per the consumer price index(CPI) stood at 14.72% in November 2013. Within food inflation, vegetable prices rose by 61.6% and fruit prices rose by 15%, in comparison to November 2012.
Hence, a large part of inflation is being driven by food inflation. As the RBI said in the Mid-Quarter Monetary Policy Review: December 2013 statement released on December 18, 2013, “Retail inflation measured by the consumer price index (CPI) has risen unrelentingly through the year so far, pushed up by the unseasonal upturn in vegetable price.”
A major reason behind the Rajan led RBI not raising the repo rate was the fact that they expect vegetable prices to fall. “Vegetable prices seem to be adjusting downwards sharply in certain areas,” it said in the monetary policy review statement. Taimur Baig and Kaushik Das of Deutsche Bank Research in a note dated December 18, 2013, said “vegetable prices, key driver of inflation in recent months, have started falling in the last couple of weeks (daily prices of 10 food items tracked by us are down by about 7% month on month(mom) on an average in the first fortnight of December).”
If vegetable prices in particular and food prices in general do come down then both the consumer price and wholesale price inflation are likely to fall. If we look at the RBI’s decision to not raise the repo rate from this point of view, it looks perfectly fine.
But there is another important data point that one needs to take a look at. And that is core retail inflation. If one excludes food and fuel constituents that make up for around 60% of the consumer price index, the core retail inflation was at 8% in November 2013. This needs to be controlled to rein in inflationary expectations. As the monetary policy review statement of the RBI points out “High inflation…risks entrenching inflation expectations at unacceptably elevated levels, posing a threat to growth and financial stability.”
According to a recent survey of inflationary expectations carried out by the RBI, Indian households expect consumer prices to rise by 13% in 2014. Th rate of inflation that people(individuals, businesses, investors) think will prevail in the future is referred to as inflationary expectation. Inflationary expectations can be reined in to some extent by raising interest rates. As Baig and Das said in a note dated December 16, “RBI would still want to maintain a hawkish stance to ensure that inflation expectations (which is firmly in double digit territory as per recent surveys) do not rise further.”
The trouble here is that higher interest rates will dampen consumer expenditure further. At higher interest rates people are less likely to borrow and spend. The businesses are less likely to expand. This is reflected in the private final consumption expenditure(PFCE) number which is a part of the GDP number measured from the expenditure point of view. The PFCE for the period between July and September 2013 grew by just 2.2%(at 2004-2005 prices) from last year. Between July and September 2012 it had grown by 3.5%. The PFCE currently forms around 59.8% of the GDP when measured from the expenditure side.
The lack of consumer demand is also reflected in the index of industrial production(IIP), a measure of industrial activity. For October 2013, IIP fell by 1.8% in comparison to the same period last year. If people are not buying as many things as they used to, there is no point in businesses producing them. It is also reflected in manufactured products inflation, which forms around 65% of WPI. It stood at 2.64% in November 2013.
When the demand is not going up, businesses are not in a position to increase prices. And that is reflected in the manufacturing products inflation of just 2.64%. It was at 5.41% in November 2012.
Given this, if the Rajan led RBI were to keep raising the repo rate to bring down inflationary expectations, it would kill consumer demand further. The Congress led UPA government won’t want anything like this to happen in the months to come. They have already messed up with the economy enough.
Hence, Rajan and the RBI would have to make this tricky decision. If the keep raising the repo rate, chances are they might be able to rein in inflationary expectations and hence inflation, in the time to come. Nevertheless, if they keep doing that the chances of the Congress led UPA in the Lok Sabha elections will go down further.
To conclude, when Arthur Burns was appointed as the chairman of the Federal Reserve on January 30, 1970, president Richard Nixon had remarked,“I respect his independence. However, I hope that independently he will conclude that my views are the ones that should be followed”. Burns had not disappointed Nixon and started running an easy money policy before the 1972 presidential election, which Nixon eventually won.
Raghuram Rajan needs to decide, whether he wants to go against the government of the day and do what Volcker did, or fall in line and help the government win the next election, like Burns did. Its a tricky choice.
The article originally appeared on www.firstpost.com on December 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)