While
economists of repute increasingly populate India's
policy-making establishment, holding regular or advisory
positions, economic policy itself seems ever more
self-contradictory. Consider, for example, the monetary
and fiscal policy recommendations being made by this
establishment as reported by the media. There is a
growing consensus within it that the Reserve Bank
of India should reduce overly high interest rates
to revive growth, even while maintaining a close watch
on inflation. In this view, inflation is a threat,
but not so much as to warrant stifling growth with
high interest rates. Responding to this pressure the
RBI has in its recent annual policy statement decided
to go in for a significant half-a-percentage-point
reduction in the repo rate.
Meanwhile another argument is gaining ground that
fiscal policy should play a greater role in controlling
inflation. The magic remedy for inflation being recommended
by adherents to this view is a reduction in the fiscal
deficit on the government's budget. Besides being
based on the belief that a reduced fiscal deficit
would automatically rein in inflation, this recommendation
is noteworthy for the specific way in which the reduction
is sought to be ensured. The government is being urged
to reduce its expenditure to curtail the deficit by
raising administered prices and user charges and cutting
budgetary subsidies. More specifically, a case is
being made out for raising the prices of petroleum
products so as to reduce subsidies or transfers to
the oil marketing companies. In recent times this
establishment demand has become an orchestrated campaign.
The argument from sources in the Finance Ministry
and the Planning Commission seems to be that if you
raise a set of prices that would reduce the fiscal
deficit, the overall rate of price increase would
be lower and not higher.
This push for raising administered prices to reduce
the fiscal deficit is supported by other similarly
''potent'' arguments. For example, former IMF chief
economist and advisor to the Prime Minister, Raghuram
Rajan, has at a function held to release the second
edition of a festschrift in honour of Manmohan Singh,
reportedly called for a complete freeing of diesel
prices in order to rein in the fiscal deficit and
boost the confidence of foreign investors.
All this is confusing indeed. It is known that since
petroleum products are in the nature of universal
intermediates, increases in their prices inevitably
have a cascading effect on costs and prices of other
commodities and result in an acceleration of inflation.
And since cost-push inflation is unlikely to be smothered
by reduced demand, it would be realised despite any
reduction in the fiscal deficit that may ensue. So,
while the RBI is being advised to cautiously stimulate
demand and growth, while keeping a watch on inflation,
the Finance Ministry is being cajoled into stoking
inflation by hiking a range of prices.
This policy muddle is all the more disconcerting since
it seems to be accompanied by a misreading of the
inflation scenario. The case for reducing interest
rates is backed by evidence that annual inflation
as measured by month-on-month Wholesale Price Index
(WPI) trends is much below its recent peak and still
declining. However, other evidence suggests that inflation
in India still rules high. According to the recently
released Consumer Price Index (CPI) numbers for March
2012, the annual month-on-month rate of inflation
had risen to 9.5 per cent from 8.8 per cent in February
and 7.7 per cent in January (see Chart). Since this
new series of All India Consumer Price Indices (with
2010 as base) are being released only from January
2011, these are the only months for which inflation
figures can be calculated as of now.
Chart
1 >> (Click
to Enlarge)
Those figures point in two directions. First, that
inflation at the retail level is high and rising,
especially because of inflation in the prices of food
articles such as milk and milk products, vegetables,
edible oils and eggs, meat and fish, besides fuels.
Second, that there is a growing divergence in inflation
trends based on the WPI, on the one hand, and the
CPI, on the other, with inflation based on the WPI
ruling lower and falling from 7 per cent in February
to 6.9 per cent in March.
To recall, the official justification for the release
of the new CPI series was the argument that the WPI
was not reflecting retail price trends adequately
and that inflation measurement based on retail consumer
prices was the international practice. The release
therefore marked the beginning of a transition in
which the government and central bank were to rely
on this new index rather than the WPI to compute the
''benchmark'' inflation rate in the economy.
Preponderant among the goods that enter the nation's
consumption basket and therefore the CPI would be
food articles and fuels. The supply of the former
articles is more volatile (because of variable monsoons,
for example) as well as less responsive in the short
run to changes in demand. Their prices, therefore,
tend to be more buoyant than that of most other commodities.
On the other hand, because of political and economic
developments in countries contributing a major part
of the world's energy supplies, the fuels component
of the consumption basket is also more ''inflation''
prone than many other goods. In the event, there is
a significant threat of an acceleration of inflation
as measured by the CPI.
Since according to that yardstick inflation is still
with us and would possibly climb, it could be argued
that the RBI, which is convinced that a hike in interest
rates is the appropriate weapon against inflation,
was pushed into cutting interest rates at this point.
However, the muddle over policy seems to afflict the
RBI as well. In its recent assessment of Macroeconomic
and Monetary Developments over the last financial
year, the central bank has also come out in favour
of increases in petroleum product prices and other
input prices to address the threat posed by ''suppressed
inflation''. That is, since the transmission of international
prices is inevitable, imported inflation can only
be suppressed and not avoided. And, if supressed,
inflation is a threat. However, if that be the case,
since further inflation is almost a certainty, the
RBI by its own logic would be forced to reverse its
interest rate reduction decision. Why cut interest
rates then?
Perhaps recognising this contradiction the RBI states:
''The upside risks to inflation on the one hand and
the depressed domestic growth outlook on the other,
warrant calibrated measures to maintain a sustainable
balance in a dynamic growth-inflation scenario.'' Presumably,
that is about as clear as one can get.
*
This article was originally published in The Hindu
on 20th April 2012 and is available at
http://www.thehindu.com/opinion/columns/Chand
rasekhar/article3336278.ece
