Vivek Kaul
Raghuram Rajan, the governor of the Reserve Bank of India (RBI) surprised everybody today, by choosing to not raise the repo rate. The repo rate will continue to be at 7.75%. Repo rate is the rate at which the RBI lends to banks.
Economists had been predicting that Rajan will raise the repo rate in order to rein in inflation. 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. The wholesale price inflation(WPI) number for November 2013 came in at 7.52%. In comparison the number was at 7% in October 2013.
As Taimur Baig and Kaushik Das of Deutsche Bank Research wrote in a note dated December 16, 2013 said “The upside surprise in both CPI and WPI inflation for November leaves no option for RBI but to hike the policy rate(i.e. the repo rate) by 25basis points in Wednesday’s monetary policy review, in our view.”
Along similar lines Sonal Varma, India economist at Nomura, told CNBC.com that she expected the RBI to increase the repo rate by 25 basis points(one basis point is one hundredth of a percentage). But Rajan has chosen to stay put and not raise the repo rate.
Why is that the case? The answer lies in looking at the inflation numbers in a little more detail. The consumer price inflation is primarily being driven by food inflation. Food (along with beverages and tobacco) accounts for nearly half of the index. Food inflation in November 2013 as per the CPI stood at 14.72%. Within food inflation, vegetable prices rose by 61.6% and fruit prices rose by 15%, in comparison to November 2012.
So what this tells us very clearly is that consumer price inflation is being driven primarily by food inflation. In fact, this is something that the WPI data also clearly shows. The food inflation as per WPI was at 19.93%. Within it, onion prices rose by 190.3% and vegetable prices rose by 95.3%.
The RBI expects vegetable prices to fall. Baig and Das 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).”
In case of WPI, food articles have a much lower weightage of around 14.33%. The other big contributor to WPI was fuel and power, in which case the inflation was at 11.08%. This is primarily on account of diesel and cooking gas prices being raised regularly in the recent past.
So inflation is primarily on account of two counts: food and fuel prices going up. The Reserve Bank of India cannot do anything about this. And given that raising the repo rate would have had a limited impact on high inflation.
In fact, if one looks at the WPI data a little more carefully, there is a clear case of the economy slowing down. Manufactured products form a little under 65% of the wholesale price inflation index. The inflation in case of manufactured products stood at 2.64% in November 2013.
When people are spending more and more money on buying food. They are likely to be left with less money to buy everything else. In this scenario they are likely to cut down on their non food expenditure.
And this has an impact on businesses. 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.
Interestingly, the high cost of food should translate into the cost of labour going up. At the same time, energy prices are also going up. This is reflected in the fuel and power inflation of 11.08%. But businesses have not been able to pass through these increases in the cost of their inputs, by raising the price of their final products. This is primarily because of the lack of consumer demand.
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.
In this scenario, raising interest rates would mean that people looking to borrow and spend money to buy goods, will have to pay higher EMIs. Businesses looking to borrow money and expand will also have to pay more. And this turn impacts economic growth. As the RBI’s statement today put it “The weakness in industrial activity persisting into Q3, still lacklustre lead indicators of services and subdued domestic consumption demand suggest continuing headwinds to growth.”
In this scenario the Rajan led RBI decided to keep the repo rate constant. What is interesting is that the RBI’s statement has suggested that it might raise the repo rate if the food inflation does not fall as it is expected to. “If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted,” the statement said.
Effectively, the RBI has bought some time. “The RBI has effectively given itself a one-month window to see if inflation actually eases in December to decide on future monetary policy action,” wrote Baig and Das of Deutsche.
In fact, Raghuram Rajan’s decision not to raise the repo rate has been seen as a surprise primarily because he has made several comments in the public saying that inflation was running higher than the comfort level. Also, Rajan is seen as an inflation fighter, and by not raising the repo rate, he has put that image at risk.
As Robert Prior-Wandesforde, director of Asian economics research at Credit Suisse, recently wrote “The data pose the now familiar dilemma for the central bank. While the direct effect of interest rate hikes on inflation is debatable, particularly when food prices are such an important driver, we very much doubt Dr. Rajan can be seen to be sitting on his hands at this stage …”To do so, would be take risks with his inflation fighting credentials,” he added.
It is hard to believe that Rajan will these credentials at risk. And given that we might just see a repo rate hike early in the new year.
The article originally appeared on www.firstpost.com on December 18, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
WPI
Explained: What the two sides of inflation tell us about the economy
Vivek Kaul
“So there is yet another inflation piece that I need to write,” he said, in a rather disappointed tone.
“Oh, but didn’t you just write one a few days back,” she replied. “And I was so looking forward to spending the afternoon at Phoenix Mills.”
“Ah. Safes me the trouble,” he said. “And for once I don’t have to eat that fancy, expensive and bland pasta in white sauce, that you make me eat.”
“But how come you need to write something on inflation so soon?” she asked ignoring the pasta jibe. “Didn’t you write one on Friday?”
“Yes I did. But that was a piece around consumer price inflation (CPI). Today the wholesale price inflation number has come out.”
“Oh,” she said. “And how bad is it?”
“The wholesale price inflation(WPI) number for November 2013 came in at 7.52%. In comparison the number was at 7% in October 2013. Interestingly, the WPI number for September 2013 was revised to 7.05%, from the earlier 6.46%.”
“And what does that tell us?”
“What that tells us is that the WPI numbers after September are also likely to be revised upwards,”he said.
“Hmmm. So inflation might be more than what we are being told right now?”
“Yes. Also, the food inflation was at 19.93%. Within it, onion prices rose by 190.3% and vegetable prices rose by 95.3$. Interestingly, the onion prices have fallen by 5.1% between October and November 2013. But potato prices have risen by 30.8% in the same period.”
“Yeah. I bought both onions and potatoes recently and realised that.”
“But food inflation at nearly 20% is what is making the scenario difficult for most people. Half of the expenditure of an average Indian household in India is on food. In case of the poor it is 60%. Over the last few years the government has gone on a spending spree in rural India, in the hope of tackling poverty. It has led to wages in rural India going up by 15% per year, over the last five years.”
“But isn’t that good?”
“Well, not in an environment where food prices are going up by 20%. You must remember that half of the expenditure of an average Indian family is on food.”
“And that is having other economic repercussions?” she asked.
“Yes. When people spend significantly more money on food, they are likely to cut down on other expenditure. And this also reflects in inflation data.”
“How?”
“Manufactured products form a little under 65% of the wholesale price inflation index. The inflation in case of manufactured products stands at 2.64%. So inflation is primarily being driven by food articles. The other big contributors to inflation have been cooking gas and diesel, which have risen by 10.9% and 15.7% respectively.”
“Oh, is that really the case. I did not know that,” she replied. “But why are the prices of manufactured products not going up as fast as of the food articles and fuel?”
“I think I have already explained that to you.”
“Really?”
“Yes. When people are spending more and more money on buying food. They are likely to be left with less money to buy everything else. In this scenario they are likely to cut down on other expenditure.”
“Other expenditure?”
“It could be anything. From buying consumer durables to cars to everything without which one can do without in the immediate future.”
“And this has an impact on businesses?” she asked.
“Yes. 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.”
“Interesting.”
“Yes, what this really means is that business growth is slowing down and this in turn will be reflected in slow economic growth as well.”
“Hmmm. Thanks for explaining this to me.”
“My pleasure.”
“So why don’t you finish writing this and then we will go increase the other expenditure.”
“You mean pasta in white sauce?” he asked.
“Yes. Remember we are doing this for the nation.”
The article originally appeared on www.firstpost.com on December 16, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
If only Raghuram Rajan could control onion prices too
Vivek Kaul
On November 12, the rupee touched 63.70 to a dollar. On November 13, Raghuram Rajan, the governor of the Reserve Bank of India (RBI) decided to address a press conference. “There has been some turmoil in currency markets in the last few days, but I have no doubt that volatility may come down,” Rajan told newspersons.
Rajan was essentially trying to talk up the market and was successful at it. As I write this, the rupee is quoting at at 63.2 to a dollar. The stock market also reacted positively with the BSE Sensex going up to 20,568.99 points during the course of trading today (i.e. November 14, 2013), up by 374.6 points from yesterday’s close.
But the party did not last long. The wholesale price inflation (WPI) for October 2013 came in at 7%, the highest in this financial year. In September 2013 it was at 6.46%. In August 2013, the WPI was at 6.1%, but has been revised to 7%. The September inflation number is also expected to be revised to a higher number. The stock market promptly fell from the day’s high.
A major reason for the high WPI number is the massive rise in food prices. Overall food prices rose by 18.19% in October 2013, in comparison to the same period last year. Vegetable prices rose by 78.38%, whereas onion prices rose by 278.21%.
Controlling inflation is high on Rajan’s agenda. “Food inflation is still worryingly high,” he had told the press yesterday. In late October, while announcing the second quarter review of the monetary policy Rajan had said “With the more recent upturn of inflation and with inflation expectations remaining elevated… it is important to break the spiral of rising price pressures.”
If Rajan has to control inflation, food inflation needs to be reined in. The trouble is that there is very little that the RBI can do in order to control food inflation.
A lot of vegetable growing is concentrated in a few states. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a report titled Agri 101: Fruits & vegetables—Cost inflation dated October 7, 2013, “While the Top 10 vegetable producing states contribute 78% of national production, the contribution of West Bengal, Orissa and Bihar is much higher than their contribution to overall GDP. For example, despite being just 2.7% of India’s land area and 7.5% of population, West Bengal produces 19% of India’s vegetables, dominating the production of potatoes, cauliflowers, aubergines and cabbage. In fact, for almost each crop, the four largest states are 60% or more of overall . In particular, Maharashtra dominates the onion trade (45% of national production by value), while West Bengal produces 38% of India’s potatoes, 49% of India’s cauliflower and 27% of India’s aubergines (brinjal). ”
The same stands true for fruits as well. As the Credit Suisse analysts point out “Maharashtra (MH) dominates citrus fruits (primarily oranges), Tamil Nadu (TN) produces nearly 40% of India’s bananas, Andhra Pradesh (AP) is Top 3 in all the three major fruits, and Uttar Pradesh (UP) produces a fifth of India’s mangoes.”
Hence, the production of vegetables as well as fruits is geographically concentrated. What this means is that if there is any disruption in supply, there is not much that can be done to stop prices from goring up. Given the fact that the production is geographically concentrated, hoarding is also easier. Hence, it is possible for traders of one area to get together, create a cartel and hoard, which is what is happening with onions. (As I argue here). There is nothing that the RBI can do about this. What has also not helped is the fact that the demand for vegetables has grown faster than supply. As Mishra and Shankar write “Supply did respond, as onion and tomato outputs grew the most. But demand rose faster, with prices supported by rising costs.” Hence, even if food inflation moderates, there is very little chance of it falling sharply, feel the analysts.
This is something that Sonal Varma of Nomura Securities agrees with. As she writes in a note dated November 12, 2013 “On inflation, vegetable prices have not corrected as yet and the price spike that started with onions has now spread to other vegetables. Hence, CPI (consumer price inflation) will likely remain in double-digits over the next two months as well.” The consumer price inflation for the month of October was declared a couple of days back and it was at 10.09%.
Half of the expenditure of an average household in India is on food. In case of the poor it is 60% (NSSO 2011). The rise in food prices over the last few years, and the high consumer price inflation, has firmly led people to believe that prices will continue to rise in the days to come. Or as economists put it the inflationary expectations have become firmly anchored. And this is not good for the overall economy.
As Varma puts it “For a sustainable decline in inflation to pre-2008 levels, the vicious link between high food price inflation and elevated inflation expectations has to be broken. The persistence of retail price inflation near double-digits for over five years has firmly anchored inflationary expectations at an elevated level. The role of monetary policy in tackling food price inflation is debateable.”
What she is saying in simple English is that there not much the RBI can do to control food inflation. It can keep raising interest rates but that is unlikely to have much impact on food and vegetable prices.
Varma of Nomura, as well as Mishra and Shankar of Credit Suisse expect food inflation to moderate in the months to come. But even with that inflation will continue to remain high.
As Varma put it in a note released on November 14, “Looking ahead, we expect vegetable prices to further moderate from December, which should lower food inflation. However, this is likely to be offset by other factors. Domestic fuel prices remain suppressed and the release of this suppressed inflation (especially in diesel) will continue to drive fuel prices higher. Also, manufacturer margins remain under pressure and hence the risk of further pass-through of higher input prices to output prices, i.e., higher core WPI inflation, is likely.”
What this means is that increasing fuel prices will lead to higher inflation. Also, as margins of companies come under threat, due to high inflation, they are likely to increases prices, and thus create further inflation.
All this impacts economic growth primarily because in a high inflationary scenario, people have been cutting 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. And people not spending money is bad for economic growth.
If India has to get back to high economic growth, inflation needs to be reined in. As Rajan wrote in the 2008 Report of the Committee on Financial Sector Reforms “The RBI can best serve the cause of growth by focusing on controlling inflation.” The trouble is that there is not much that the RBI can do about it right now.
The article originally appeared on www.firstpost.com on November 14, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)