The Hindu Business Line : Kudos in line on inflation management

Data show that inflation in various CPI measures eased to a range of 6.2-8 per cent in March 2008 from 10.9-12.2 per cent in March 2007. This is definitely a credible achievement in inflation management. Why do the RBI and Government of India refrain from taking credit for it?

The RBI Governor, Dr Y. V. Reddy…Measures to raise CRR were well-timed.

S. Venkitaramanan

The RBI’s Annual Credit Policy has come and gone and the markets and the economy are reacting to the initiatives of the RBI. It is obvious that the Governor/RBI has been proved correct in his judgment of the inflationary potential in the economy and his measures to raise the CRR before the credit policy were, indeed, well-timed. Hats off to him! I propose to devote this piece to an analysis of the document on macroeconomic and monetary developments for 2007-08 issued by the RBI just before the announcement of the Annual Monetary Policy statement for 2008-09.

The centre piece of the discussion is obviously on various macroeconomic aggregates, including, in particular, the growth of credit and money supply. But there are some details that bear detailed scrutiny. The total growth of bank credit as on January 16, 2007 was 30.1 per cent, while that in February 2008 was 22 per cent. The decrease in credit has not led to a decrease in inflationary potential. In fact, the latter period saw a higher increase in price inflation.

Turning to details of distribution of credit, I find that the continued emphasis of the RBI for reducing real-estate loans has had some impact. Whereas in the previous 12 months’ period, the rate of growth for credit for real-estate was 79 per cent, it has been only at 26.7 per cent in the latest period. Non-Banking Finance Companies have, however, attained a general rate of growth of 48 per cent compared to 29 per cent in the last year.

The loans against consumer durables have, however, shown a sharp decrease from 27.4 per cent to 5.0 per cent. Loans for this sector have a crucial role in promoting manufacturing sector’s growth. The real-estate loans have also shown a sharp decrease in the rate of growth from 79 per cent to 26.7 per cent. But real-estate loans are the basis of housing investment, as also of new initiatives, such as special economic zones (SEZ) projects.

Slackening on the agri front

The review, however, reveals that agricultural credit has slackened. The rate of growth in the previous period was 28.6 per cent as against 16.4 per cent in the latest period. This does not fit in with Government’s stated goals of doubling agricultural credit for a short period. Obviously, the tightening of credit has to be studied in a disaggregated manner.

The data in the report show that there is, in effect, a credit crunch in force in India. In particular, if you look at priority sector lending, the rate of growth has declined from 22.9 per cent in the previous year to 16.9 per cent in 2007-08. How can the central bank achieve goals of inclusive growth when it has slackened on this important goal of priority sector credit growth?

Similar is the case with regard to housing. Whereas in the previous period there was a rate of growth of 25.8 per cent, it has declined to 12 per cent in the latest period. Whether such sharp contraction of credit on housing is in line with the overall policy goals of the Government and the Bank itself is a matter to be examined.

Inflation — case for credit

Turning to inflation, the data in the analysis clearly bring out the rise in WPI in India in the recent period in the context of global price pressures. But I am intrigued by a table that shows consumer price inflation in the country in the last two years. As the report says “Various measures of consumer price inflation were placed in the range of 5.5 per cent to 9 per cent during February-March 2008, as compared to 6.7 per cent to 9.5 per cent in March 2007”. However, disaggregate data show that inflation in various CPI measures eased to a range of 6.2 per cent to 8 per cent in March 2008 from 10.9 per cent to 12.2 per cent in March 2007. This is definitely a credible achievement in inflation management. Why do the RBI and Government of India refrain from taking credit for it?

Economic statisticians have been quick to point out that the CPI numbers are usually above the WPI variations. This is, however, not fully borne out by the experience in the last two years. There had been some periods in which the CPI variations were almost equal to those of WPI. It is time the Government of India and the RBI settle on a quicker and more effective method of determining CPI variations, which are definitely a better benchmark for policy formulations than WPI. Efforts are already on in this direction. This will also bring our policy focus in line with international practice.

Managing capital flows

Turning to the external situation, the RBI”s report points out how capital flows have been rising in the recent period and effectively made the management of inflation a difficult task. The break-up of figures on capital flows is instructive. Foreign direct investment in India in 2007-08 has risen to $25.45 billion as against $19.6 billion in 2007. The figures refer to the periods April 2007 to March 2008. As against this, FDI going out of India had been $9 billion in the previous year and of the same order in the latest period. Portfolio investments by FIIs in 2006-07 had been of the order of $3.225 billion as against $20.3 billion in the latest period 2007-08. External Commercial Borrowing has been significant, rising to a level of $16 billion in the latest period as against $9.8 billion in the previous period, reflecting the lower interest rates abroad. NRI deposits have declined substantially in the latest period as against a marginal figure of $3.9 billion in the previous figure.

Negative investment position

The overall effect of all this turns out that the net investment position of India continues to be negative. Whereas we have foreign exchange currency reserves of roughly $300 billion, the liabilities are substantially higher. FDI itself totals to a liability of $35 billion as on September 2007. The net investment as at the end of September 2007 is provisionally estimated to be of the order of (-) $68 billion as compared to a figure of (-) $62.3 billion in March 2007. These investments are on the basis of historical cost, whereas the actual market value of investment, both direct and portfolio, has increased substantially due to appreciation of the rupee till recently and the stock market changes.

The FIIs are benefited both by rupee appreciation and the market boom. For every $100 million they brought in, they can take back 20 to 25 per cent more, by virtue of the same effect. I do hope the RBI is keenly aware of this. Is there any way we can control this double-whammy effect?

So too, FDI investors. The value of FDI investments as on date also partakes of the effect of rupee appreciation as well as the rise in equity valuations, consequent on stock market boom. All this requires careful analysis.

Puzzle unanswered

On one aspect, the report does not give a proper analysis. During the last year (2007-08), the net ‘credit’ from the RBI to the Central Government was (-) Rs 11,20,000 crore as against (-) Rs 3,000 crore in 2006-07.

That is, Government of India was ‘depositing’ its cash surplus with the RBI almost equal to the fiscal deficit and still inflation rose. Is there a non-monetarist explanation for this?

The total impact of the detailed analysis by the RBI is definitely revealing, in terms of the complexity of issues that the top management of the RBI has to face in managing the economy of the country.

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