Inflation — visible and invisible

As the Reserve Bank of India (RBI) reviews the state of the economy and formulates its policy response to the emerging situation, it finds its task no less difficult than in the past.

Even if the recent reform announcements get implemented, it passes one’s comprehension as to how it will lead to a higher GDP growth in the near future, as claimed by some observers.

The opening up of retail trade, aviation, and so on, to foreign investment will take time to fructify on the ground. Even if these lead to some additional employment in the service sector, it may have only a marginal impact on the commodity sector in increasing output.

Excess liquidity

On the inflation front, there is no relief in sight. Its continued elevated levels, especially in the case of food, are likely to prevail during the rest of the year. What is disturbing is the revelation from the monthly seasonal factors in economic time series published in the RBI Bulletin of September 2012.

Although there are peaks and troughs in the wholesale price index for all commodities, the amplitude of the curve or the range between the maximum and the minimum in a year has been small or negligible like that between Tweedledum and Tweedledee. The amplitude increased from 1.1 in 2002-3 to 1.5 in 2007-8, and thereafter witnessed a steady decline to 1.1 again in 2011-12.

Among food articles, the seasonal variation is important only in the case of pulses and fruits and vegetables. The annual rise in the prices of wheat and rice at 18.6 per cent and 12.4 per cent, respectively, in September, defies logic, considering the bulging stocks lying with the Food Corporation of India. Does it mean that rising official food procurement has led to a reduction in the floating stocks in the market resulting in the price rise? It is also symptomatic of the underlying problem of excess liquidity and demand management.

Reducing size

In this context, one needs to take note of what I would call ‘invisible inflation’. It refers to a sale strategy of retaining the price of a good, while simultaneously reducing its size or the quantities offered. Manufactured goods such as toilet soaps are available in small sizes, but without any proportionate decrease in prices vis-à-vis the big ones.

Another classic example is coffee. In the distant past, restaurants used to supply the beverage in good-sized tumblers. Over the years, the size got reduced, progressively culminating in a small cup now. There is sometimes a double whammy for the consumer, as the price also ‘visibly’ goes up!

Likewise, the vegetable vendor selling the masala mixture of coriander leaves, and so on, used to earlier provide a piece of ginger ‘free’ to generate goodwill. Now, we have to buy it. It was selling around Rs 200 per kg at one time! Then there is the restrictive practice, where in the case of both masala mixture and tulsi leaves, the vendor in the Matunga market of Mumbai insists on a minimum purchase for Rs 5. What do you do with all the tulsi leaves, when you can use only three or four in any religious ceremony?

There is, indeed, no way for monetary policy to tackle such problems of ‘invisible inflation’ that any wholesale or consumer price index cannot measure!

Case for Status Quo

The RBI is concerned with liquidity at the level of the banking system.

Banks put together had an excess investment of more than Rs 500,000 crore in statutory liquidity ratio-linked securities on October 5, as against the highest amount in recent times of Rs 100,000 crore of repos availed of on October 18.

The trends in the call money market, credit-deposit ratio (75 per cent), investment in mutual funds (Rs 51,700 crore), bid-cover ratio in the auction of securities and the spurt in the total traded amount of commercial paper from Rs 3,663 crore in August to Rs 21,574 crore on October 15 are all indicative of a comfortable liquidity situation. The recent high level of repo transactions at the RBI was only due to the temporary outflow of currency in the festival season.

Going by the current trends in relation to major economic variables, there is no case for any change in the policy.

The RBI’s focus should continue to be on inflation, though there is considerable pressure on it from the banking and the corporate sectors, and also the Government, to loosen up policy in the interest of growth.

Such liberalisation can be in two ways. One is a further reduction in the banks’ cash reserve ratio (CRR) that will release primary liquidity. The other is a decrease in policy (repo and reverse repo) rates by the RBI. Under the current circumstances, the reduction in policy rates is preferable to that in CRR.

A CRR cut benefits all banks across-the-board, including those with comfortable liquidity.

The policy rates, by contrast, benefit only those accessing the RBI’s window. If the rates are reduced, it is not likely to lead to any dramatic increase in the issue of created money.

In any case, unlike the CRR, which has a feature of permanence until a change is made, the repo transactions are for only overnight, even though there are daily rollovers by many banks.

From the point of view of the public and politicians, a decline in rates is easily seen as something good. It is a no-brainer!

On the other hand, not many can understand the nuances of CRR.

Thus, from the point of view of public relations, too, a cut in rates is preferable to one in CRR being less damaging in the current economic situation.

(The author is an economic consultant.)

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