The Hindu Business Line : Overreacting to price rise?

The message conveyed by the Reserve Bank of India (RBI) through its First Quarter Review of Monetary Policy is loud and clear: Control inflation and anchor the relative expectations at a low level.

Giving up its old and bold habit of predicting inflation at a specific level at the end of the year, it has in its press release said: “While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable le vel of below 5 per cent as soon as possible and around 3 per cent over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11-12 per cent to a level close to 7 per cent by March 31, 2009.”

WPI movement

The Index Number of Wholesale Prices stood at 226 at the end of March 2008. To record an annual point-to-point inflation rate of 7 per cent it should be around 241.8 at the end of March 2009. The latest index number relating to July 12, 2008, is 239.

It is thus expected to go up further only by about three points by the year-end. It is obvious that the central bank expects absolute price falls in respect of some commodities in the coming months in the wake of the kharif harvest.

Certainly it could be brought about even earlier if the Government unloads its wheat and rice stocks at reasonable prices in the market now through a mechanism that enables the benefits reach the consumer without giving rise to scams or exploitation by intermediaries.

A beginning has been made in selling imported edible oils of limited quantities directly to consumers with “ration cards”.

Incidentally one of the commodities that has recorded a price rise in the open market is imported edible oils on which Customs duty was waived.

Where have the imports of private traders gone? In the last Annual Policy Statement, the RBI had asked banks to undertake reviews and report the findings by May 15 on the extent to which bank credit had helped in speculative hoarding of commodities. For some strange reason, the central bank is silent on the results.

GDP Growth

While none can object to the objective of bringing down inflation, there could be differences of opinion on whether the measures the RBI has announced are too harsh or whether it would hurt growth more than envisaged. The measures include repo rate increase by 50 basis points from 8.5 per cent to 9 per cent and a hike in the Cash Reserve Ratio (CRR) by 25 basis points to 9 per cent. Such high rates are being witnessed for the first time since the last quarter of 1999. The earlier tightening measures had already led to both deposit and lending rates going up. Further increases may be expected. And recent data show some sharp deceleration in industrial production.

The RBI has revised its estimate of GDP growth for the current year from 8-8.5 per cent to around 8 per cent. It would appear that this refers to a scenario before the coming into effect of the latest tightening measures.

While it may be premature to talk about a recession setting in, it appears achieving even a growth rate of 7 per cent would be a matter for satisfaction.

Money supply, bank credit

The RBI says that while there are early signs of some moderation in money supply and deposit growth, they continue to expand above the indicative projections warranting continuous vigilance and appropriate and timely policy responses.

The basic point is that money supply increases have not taken place over weeks or months but over a long period because of the central bank’s policy of accommodating 5 per cent inflation every year through its money supply targets. The RBI must, however, be credited for bringing down the liquidity overhang from an average of Rs 2,42,370 crore in April to Rs 1,45,200 crore, as on July 25, 2008.

This gradual approach should be pursued with vigour if the central bank really means business. And, what is more, it should keep this experience and its money supply sights in mind to know what is really required to fuel the growth of the economy and not inflation.

If the credit target has been crossed, it is partly because of inflation. The RBI talks only about nominal credit. It should review the trends in real credit before deciding whether there is excess credit. A good example is that of oil marketing firms which need more credit in the context of rising prices of imports.

It is further aggravated by the Government’s policy of containing the pump prices and not compensating the firms in time.

The RBI should undertake research in the area of real credit with a view to identifying the right index number of prices for various sectors to arrive at a total deflator.

Much of the credit given to firms is necessitated by increases in the prices of inputs. So one may not be surprised if there is an increase in credit to a sector even in the absence of output growth. Thus bank credit and inflation may be reinforcing each other.

Despite the tightening measures, banks have been able to sustain the credit expansion, thanks to the simple device of liquidating excess investments in government securities. Now the proportion of SLR investments to deposit liabilities has come down to only 2.7 percentage points above the prescribed ratio of 25 per cent.

Bond yields

Of late, bond market yields have been buoyant, with the 10-year bellwether bond fetching 9.5 per cent and the 91-day Treasury bill, 9 per cent. Bond yields may cross 10 per cent before long. Government will be compelled to resort to borrowings over and above the estimates given in the Budget.

Besides the loan waiver and increases in salaries of government employees necessitated by the Pay Commission recommendations, there is a plethora of subsidies. Their magnitude can only be expected to go up further in an election year.

Additional schemes, as also expeditious implementation of the existing schemes, will further strain government finances.

It is already reflected in the data relating to fiscal and revenue deficits. It may become necessary before long for the RBI to raise the SLR.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)

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