The RBI should change its inflation toolkit

In 2009, as head of the State Bank of India’s Gujarat operations, I was pulled up by the Reserve Bank of India for not having enough small coin dispensers for public convenience. Today, a ten-rupee note is considered to be the smallest unit of change by even the autorickshaw drivers!

It is not as if the RBI was a silent spectator to inflation. Governor D Subbarao started taking the first of his baby steps as far back as 2010. Within the next 15-18 month period, 13 repo rate increases totalling 3.75 per cent on a starting base of 4.75 per cent had taken place. The war against inflation was continued, if not intensified further, in 2012-13. It often appeared to lay observers that excesses of inflation seemed to worsen in tandem. But undeterred by this, Governor Raghuram Rajan continued the good fight.

Somewhere around the middle of last year, things changed on the price front. The inflation rate started falling thanks to oil prices. With inflation having been part of the election rhetoric, the newly elected government decided to press the pause button on the practice steady annual increases in the support prices for protected crops.

Whatever the reasons, inflation did fall. Concurrently, people started expecting RBI to relax its stand. However, Governor Rajan has been hesitant to yield, notwithstanding the recent 25 basis point cut in repo rate. The central bank’s foremost priority is to tame the demon of inflationary expectations.

Indeed, the reputations of central banks, the world over are made, or unmade, by how well they defend their national currency values. Some even ascribe the path that Germany took in the 1930s to the devastation which the hyperinflation of the mid/late 1920s inflicted on German society and self-esteem.

How is it that in this inter connected world, most of the advanced economies have very low or negligible inflation? Are their central bankers more able?

In India, the weight attached to food products in the consumer price index is approximately 50 per cent. All other aspects of consumption --- health, education, energy, transportation, clothing, household, entertainment --- account for the remaining weights. In the advanced economies as a group, the weightage given to food products is between 15-20 per cent. This could explain some of the difference.

We can examine economies via the relative sizes of ‘organised’ and ‘unorganised or informal’ sectors. Owing to better linkages to institutions of formal finance, monetary policy transmission is more effective in the organised sector. In India, organised sector employment is around 29-30 million, implying that the informal unorganised sector accounts for over 75 per cent of the workforce. The proportions are reversed in the advanced economies, explaining the difference in outcomes.

We could also examine economies by markets. Do we have unified markets just like the West? We could also examine role of non-market players. Especially governmental price interventions or wages stance. Are these similar? Does it impact inflation? Baseball and cricket are both ‘Bat-Ball’ two team games. The team which scores most runs, wins. Both have players doing equivalent things. Are the games similar in terms of rules of play, skill sets or strategies?

What have been the implications of RBI following ‘international’ best practices in their anti-inflationary strategy? Governor Rajan may well be right in apprehending that inflationary expectations are still around, but is he correct in assuming that RBI policies are working to reduce inflation?

Most of the constraints impacting the Indian economy fall outside the purview of the RBI. The economy is largely unorganised and informal sector-driven whereas the RBI is essentially a financial market regulator. The RBI can only use monetary sector tools. During the pre-liberalised years, RBI often intervened using micro economic tools or ‘selective credit control’ measures as they were called. Undoubtedly, they were both cumbersome, messy and intrusive.

Banks did not like it. Now they are considered passé. But faced with intractable irrationalities in the ‘real’ sector, should they not at least be reconsidered? Otherwise, is it not a case that a dengue affected patient is getting ‘anti-malarial’ treatment because only that is internationally recognised?

The writer is a former Chairman of Exim Bank of India

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