Lessons for govt from a Mumbai taxi driver: Why inflation is killing growth


Vivek Kaul

Sometimes it takes a small nudge to start doing what might later seem obvious. A few months back I happened to read Nicholas Epley’s Mindwise—How we understand what others Think, Believe, Feel and Want. Epley is a professor of behavioural science at the University of Chicago’s Booth School of Business.
In this book Epley writes that “isolating activities like commuting are some of the least pleasant of any day.” “Not only is isolation unpleasant, it is bad for your health as well.” Hence, he goes on to suggest that it always makes sense to communicate with your fellow commuters or in case of taxicabs, the drivers.
“In fact, the positive effect of talking to one’s taxi driver is particularly large. Perhaps because taxi drivers come from interesting and varied backgrounds, they seem to make especially pleasant conversational partners, at least for the length of your ride…The stories I get are fascinating, the conversations are almost always interesting, and my experience is consistently better than if I had simply stared out of the window instead…Your ability to engage with minds of others is one of your brain’s greatest abilities. You’ll be happier if you actually use it,” writes Epley.
After reading this book I have “nudged” myself in the direction of trying to have a conversation with the taxi-driver, every time I use a taxicab. Late last night I was coming back home after having dinner and starting talking to the driver. Over the last few weeks the conversation usually starts around the recent increase of the minimum cab fare in Mumbai from Rs 19 to Rs 21. And then it goes off in different directions.
Yesterday night was not different from the usual except for the way the driver reacted. He was of the opinion that the decision to increase the minimum fare from Rs 19 to Rs 21 was a stupid one and that the taxi union hadn’t been doing its job properly. The response intrigued me, given that this was the first time I came across someone who did not seem to be happy at the prospect of a higher income in these inflationary times.
I asked him to explain in detail what he meant. “Main to kehta hoon minimum pandrah rupaiye kar dena chahiye, (I think the minimum taxi fare should be reduced to Rs 15),” he immediately responded. This intrigued me further. “Log taxi le nahi rahe hain. Kaafi samay khaali baithe rehna padta hai (People are not taking taxis and for long periods of time I am just sitting idle),” he continued.
And then he went on to explain that at a lower fare he would get more customers, wouldn’t have to sit idle for long periods of time during the day and would in the process end up making more money, even though the amount of money he would make per kilometre would be lower. Sometimes wisdom strikes you at the most unlikely of places. Last night I had that kind of a experience.
High inflation has been the bane of this country over the last five years. And that has hit all kinds of people including the taxi-driver I was talking to last night. When fares are raised, it means a higher price for hiring a cab for the end consumer. And he or she is not always ready to pay for that. Hence, an increase in taxi fare, which is basically inflation for the end consumer, leads to loss of business for the taxi-driver.
The way it works for the taxi-driver at the individual level, also works for the society as whole at a much broader level. As prices rise, people cut down on the consumption of non-essentials. Due to high inflation people have had to spend more money on meeting daily expenditure. Food inflation in particular has been greater than 10% over the last few years, and has only recently started to come down a little.
Given this, people have been postponing all other expenditure and that has had an impact on economic growth. Anyone, with a basic understanding of economics knows that one man’s spending is another man’s income, at the end of the day. When consumers are going slow on purchasing goods, it makes no sense for businesses to manufacture them.

This is reflected in the index of industrial production, which is a measure of the industrial activity within the country. Numbers released yesterday by the Central Statistics Office showed that for the month of July 2014, the index of industrial production grew by a minuscule 0.5% in comparison to July 2013. This was largely on account of a slowdown in manufacturing, which forms nearly three-fourths of the index of industrial production. It contracted by -1%. Many sectors within manufacturing like tobacco, apparels, paper and paper products, communication, publishing, furniture etc, contracted majorly.
This is worrying given that the expansion of the manufacturing sector remains India’s best bet to create jobs at a fast pace, for its semi-skilled workforce. And manufacturing cannot be turned around unless inflation is brought under control, so that consumer demand revives, and in turn encourages businesses to increase production of goods. Interestingly, August 2014 saw a major revival in car sales with sales going up by more than 15%.
Along with the index of industrial production, the Central Statistics Office also released the consumer price inflation number, yesterday. Inflation in August 2014 stood at 7.8%. This was a tad lower in comparison to the inflation in July 2014, which was at 7.96%. The inflation in July 2013 had stood at 9.52%.
While this is clearly good news, the worrying bit is that food inflation continues to remain high at 9.42%. In July 2014 the number had stood at 9.36%. In August last year, the number had stood at 11.11%. “In the case of food articles, price pressures were seen building up in pulses, condiments & spices and milk & milk products. Inflation in each of these categories has been rising for the last 3 months,” Crisil Research pointed out in a research note yesterday.
As I have often pointed out in the past, half of the expenditure of an average household in India is on food. In case of the poor it is 60%. If consumer demand is to be revived then food inflation needs to be brought under control.
Analysts believe that consumer price inflation will continue to fall in the months to come. A major reason for this is the fall in global oil prices. “A significant decline in petrol prices (Rs 5.4 per litre since July in Mumbai) due to lower crude oil prices globally, is also likely to have contributed to the downward price pressures in transport & communication. We expect this to continue going forward as no further hike in diesel prices is expected as long as crude oil prices stay at current levels,” Crisil Research points out.
On the flip side, a weak monsoon has led to the build up of “inflationary expectations” (or the expectations that consumers have of what future inflation is likely to be). And this could play a spoiler in reviving consumer demand.
In the long run, other than bringing down inflation the government needs to carry out structural reforms in order to revive Indian manufacturing. As Crisil Research points out “Incremental policy measures and bureaucratic improvements that the new government has taken in its first 100 days to improve the ease of doing business, has had a positive impact on business sentiments. However, it will take some time for these to translate into growth. While these are critical to lift growth in the short-term, the government needs to move forward with structural policy reforms such as implementation of GST (Goods and services tax), easing labour laws, rationalisation of fiscal subsidies, and amendment of land acquisition norms, to maintain the growth momentum beyond this year.” And that is easier said than done.
The article originally appeared on www.FirstBiz.com on Sep 13, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

Will Rajan do a Volcker before 2014 Lok Sabha elections?

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) 

November CPI at 11.24: Here is why we have got those inflation blues

B. B. KINGVivek Kaul
Hey, Mr. President,
All your congressmen too,
You got me frustrated,
And I don’t know what to do

I’m trying to make a living,
I can’t save a cent,
It takes all of my money,
Just to eat and pay my rent

I got the blues,
Got those inflation blues

Or so go the lines of a song sung by the American blues musician BB King. (You can hear the complete song here). The United States and other parts of the Western world are currently going through an environment of very low inflation. But India definitely has got what King called the inflation blues.
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. Within CPI, the food inflation was at 14.72%. And within food inflation, vegetable prices rose by 61.6% and fruit prices rose by 15%, in comparison to November 2012.
The purchasing power of rupee has gone down. In simple terms, a rupee buys significantly lesser stuff than it did a year back. Or as King put it:
Now you take that paper dollar,
It’s only that in name,
The way that buck has shrunk,
It’s a lowdown dirty shame.
Why has this happened? In the first seven months of the current financial year i.e. the period between April 1, 2013 and October 31, 2013, the government of India spent around 99% more money than it earned. Yes, you read it right. During the period it earned Rs 4,64,123 crore and it spent Rs 9,22,009 crore, which is 98.7% more.
It has followed this practice, where it has spent much more than it has earned, over the last few years. This increase in spending has largely been account of government doles like a higher minimum support price being offered for rice and wheat being sold by farmers to the government.
These doles are being handed out to the citizens of this country, in the hope that they will continue to vote for Congress led United Progressive Alliance (UPA) government.
This excessive government spending has not been matched by an increase in production. This means, that an increased amount of money has been chasing a similar number of goods and services and that has led to higher prices i.e. inflation.
jhollawallahs who think they have their heart in the right place (and everyone else is a bourgeois) have often made the argument that the government is only spending money on the poor. This spending has led to rural wages rising at 15% per year, over the past five years. This is the fastest in Asia.
The trouble is that productivity has not risen at the same rate. Hence, the amount of goods and services being produced have not risen at the same rate as income. This, as explained earlier, has led to more money chasing the same number of goods and services, leading to high inflation.
And this hurts the poor the most. In fact, rural inflation for November 2013, stood at 11.74%, significantly higher than the urban inflation of 10.53%. What is worse is the fact that food inflation is close to 15% and vegetable prices have risen by greater than 60% in the last one year.
As I have often pointed out in the past, half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). So, inflation hurts the poor the most. If that was not the case, the Congress party wouldn’t have lost the recent state assembly elections so badly. Yes, rural wages have gone up, but the question is whether they have gone up enough to compensate for higher prices?
A higher inflation also leads to the regular expenditure of people as a proportion of income going up. Given this, they need to cut down on expenditure on non essential items like consumer durables, cars etc, in order to ensure that they have enough money in their pockets to pay for food and other essentials. Or as King put it:
And things are going up and up and up and up,
And my cheque remains the same,
That’s why I got the blues,
Got those inflation blues.
This ultimately reflects 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. This is reflected in the slowdown in manufacturing which forms 75% of the IIP. It fell by 2% in October 2013.
When we look at IIP from the use based point of view, the production of basic goods, which have most weight, fell by 1.6%. The production of consumer goods and consumer durables fell by 5.1% and 12% respectively.
All this ultimately leads to slower economic growth. Given this, if India needs to get back to the high economic growth rates of the past, it first needs to kill high inflation. But that is easier said than done.

The article originally appeared on www.firstpost.com on December 13, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Inflation over 10%: India needs a Rajiv Gandhi Inflation Control Yojana

RAJIV_158869fVivek Kaul
But Ma I want to become an economist,” said the son.
An economist?” asked the mother. “Why in the world do you want to do that? You are already a politician.”
“Aren’t they kind of cool?” asked the son.
Care to explain?”
“Look at Rajan at the Reserve Bank, the women are just swooning over him,” said the son. “Mrs De even wrote a column on how hot he is.”
“Yes. But do you remember the one before Rajan? No woman would have fallen for him, even though he did try and learn the salsa dance,” said the mother, puncturing the bubble.
Ah, trust you to spoil the fun as always,” said the son. “I was so looking forward to the women swooning over me.”
“Aren’t they already,” replied the mother, trying to do some damage control. “Look at the number of responses we have got to that advertisement we placed on 
globalshadi.com. Wanted a fair, convent educated, homely girl who respects her elders and can cook.”
He He.”
“But why do you suddenly want to become an economist?”
Oh, every other day the media talks about inflation, index of industrial production and what not,” said the son. “And I don’t understand any of it.”
“But you don’t have to understand all that 
beta,” said the mother. “What else do we have mauni baba for?”
“Oh yeah, 
mauni baba is an economist, I had almost forgotten, given that he rarely speaks these days.”
“Yes. Let me just call him for you.”
Five minutes later, 
mauni baba is hurried in through the door.
What happened madam?” he asked. “Hope all is well.”
“Nothing really,” she replied. “My son here just had a few small doubts. I’ll leave the two of you alone to have a man to man talk.”
Saying this, the mother left the room and the son decided to brush up on his economics.
“You know sir, the index of industrial production(IIP) number came in earlier in the day and it rose by 2%.”
“Yes, it did 
beta. What do you want to know about it?” asked mauni baba rather lovingly.
“Why is the number so low?”
“We are going through tough times. You know the IIP essentially measures the level of the industrial activity in the country.”
“But isn’t 2% very low?”
“Yes it is. In fact, if we look at just manufacturing which forms 75% of the IIP, it grew by only 0.6%.”
“Oh, so low?”
“Yes,” said 
mauni baba. “The industrial activity in the country has come to a standstill.”
“But why is that?” asked the son.
People are not buying as many cars as they were. Neither are they buying consumer durables, which fell by 10% during September 2013, in comparison to the same period last year,” said mauni baba, without answering the question.
“But what is the problem?”
“The problem is inflation. The consumer price inflation for the month of October 2013 was at 10.09%.”
“Oh, yes I saw that on television,” said the son. “They keep going on and on about onion and tomato prices going up. I am so bored of watching that.”
“Yes, you should watch Star World Premiere HD.”
“And if they can’t eat onions and tomatoes, why don’t they try pasta and pizza,” said the son. “Or even caviar.”
“Doesn’t go down well with the Indian taste, you know,” said 
mauni baba. “We need our dal, rice and rasam.”
So you were telling me something about inflation.”
“Yes. So inflation is greater than 10%. Food inflation is higher. Consumer price inflation number suggests that food inflation is at 12.56%. As per the wholesale price inflation number, the food inflation is at 18.4%.”
“And what does that mean?”
“Half of the expenditure of an average Indian household goes towards food. Given the rate at which food prices are rising, more and more money is being spent on paying for food and other essentials.”
“Hence, there is very little money left to buy non essential items like consumer durables and cars. And this leads to low industrial activity. When the demand falls, so does the supply.”
“But where does this inflation come from?” asked the son. “Why can’t we just stop it by launching a RGICLY?”
“RGICLY?” asked 
mauni baba. “What is that?”
“Rajiv Gandhi Inflation Control Yojana,” explained the son, very seriously.
“We can try, we can try,” said 
mauni baba going with the flow.
“But where does this inflation come from?”
Well, over the last few years, the government has increased its expenditure. All this money being spent lands up in the hands of people. And they go out and spend that money. When a greater amount of money chases the same amount of goods and services, prices rise. Food prices particularly work along these lines.”
“Ah. So basically we need to grow more onions and tomatoes.”
“Yes, yes,” said 
mauni baba. Its an opportune time to launch IGKTUY.”
“IGKTUY?” asked, the confused son. “What is that?”
“Indira Gandhi Kaandha Tamatar Ugaao Yojana.”
“Kaandha why not just Pyaaz or Pyaaj?” asked the son. “No one understands Kaandha in North India.”
“Oh, I just though IGK comes in a sequence and thus, sounds better,” 
mauni baba explained.
“IGK or IJK?” asked the son.
“Oh, never mind.”
“But now I get it. Basically inflation is killing growth,” said the son.
“Yes, in fact there is even a term for it.”
“And what is that?”
“Stagflation, which is a combination of stagnation and inflation.”
“Ah, stagflation,” said the son. “I quite like the term. Reminds me of all the stag parties I used to attend.”
“So can I go now?” asked 
mauni baba.
Wait, wait, wait,” said the son. “I just understood what you were really trying to say.”
“That, mother is essentially responsible for everything. She was the one who got the government to increase its expenditure and spend much more than it earned, which is what finally led to inflation.”
“But I didn’t say that,” 
mauni baba protested.
You did not. But that was what you meant,” said a confident son. “Mother won’t like listening to this.”
“Ah. You are making the same mistake as other people.”
“They don’t call me 
mauni baba just for nothing,” said mauni baba and walked out confidently from the room.
The mother soon came back into the room and the son told her everything. As he finished, the mother burst out into a hearty laugh.
You know, this is quite unbelievable,” she said. “You want me to believe that for the last half an hour mauni baba was speaking and you were listening?”
The article originally appeared on www.firstpost.com on November 13, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)