A Seshan

Let’s wait and watch this summer

A SESHAN | Updated on January 23, 2018

Blast from the past Will food inflation return? N Sridharan

Besides expecting banks to pass on earlier rate cuts, inflation concerns contributed to RBI keeping rates unchanged

The Reserve Bank of India’s first bi-monthly review for the current fiscal year makes no changes in the policy rates and ratios. As the governor said in the press conference, it is status quo only in monetary policy but not in the efforts being made to improve the working of the system and the economy. Besides the review of trends in domestic and international economy and the rationale for keeping the rates unchanged, the document also carries important regulatory measures relating to such areas as banking structure, financial markets, the issue of rupee bonds in foreign countries by Indian companies, and the promotion of investment in gilt-edged securities by individuals.

The RBI used to announce its annual policy at the beginning of each financial year after studying the Budget and its implications for the economy. This practice seems to have been given up. The current review is described as the “First Bi-Monthly Monetary Policy Statement 2015-16”. There is a detailed Monetary Policy Report accompanying the review that is available on the RBI’s website.

A pendulum swing

In the past, I used to argue against the bank giving any estimates of money supply growth in the fiscal year as it had given up its Friedmanian policy of monetary targeting, advocated by the Chakravarty Committee (1985). Now the RBI has stopped giving projections of deposit/credit/money supply growth. It has also gone to the other extreme of not discussing these variables either in the policy review or in the policy report.

It would have been appropriate to present some data, discussing the trends and the underlying causes. There is a section on liquidity conditions in the report with charts but a table would have been more helpful. The definition of liquidity adopted by the RBI to monitor market conditions, would have been appropriate.

In the past the RBI used to give such a definition and present data on the overhang of liquidity that guided its policy stance. One would like to know from it whether there has been a change in money multiplier in the context of the campaign for financial inclusion.

I am not sure of the projections of the Bank for inflation in the current year and FY2017. CPI inflation is projected at current levels in the first quarter of 2015-16 moderating thereafter to around 4 per cent by August but firming up to reach 5.8 per cent by the end of the year. The Review takes note of the adverse weather conditions in the recent months but is not overly perturbed by the extent of damage to crops appearing in newspaper reports. Summer is generally the time for prices to rise before they go down with the arrival of kharif crops.

Forward purchases

It is quite likely that this summer may see a resurgence of double-digit inflation, attributable to vegetables and fruits that have suffered extensively, besides cereals and pulses. Supply management is going to be crucial. What is the use of holding bulging stocks of grains if they are not released in the market to control prices? The rabi procurement of wheat starting on May 1 will add to the problem of dwindling stocks in the market. The government should not have any ambitious target for wheat procurement but instead try to reduce the stocks in the godowns.

As far as vegetables are concerned, the government should think of entering into forward purchases abroad with imports so arranged in different ports that inland transportation costs are reduced. There is a transportation model in linear programming that tackles the question of where the imports could land so that they are close to the consuming centres.

One does not know whether the officials concerned are familiar with the technique. They can take the help of the management schools and experts in operations research. The contract for forward purchase may provide for cancellation if later imports are found to be not necessary. No doubt there will be penalties for such cancellations, but the costs should be balanced against the benefits of price stability. The country has sufficient exchange reserves to afford to import vegetables and fruits.

Anti-inflationary undercurrent

The governor pointed out in the press conference that there had not been a satisfactory transmission of the reduction in repo rates to lending rates. Probably this was also at the back of his mind when he decided against any further cut in the rate. Such a cut would only augment the profits of banks borrowing from the RBI with no benefit to the ultimate consumer of credit. He advocated marginal costing of the base rate. It is not likely to be acceptable to banks that would like the average cost of funds to be the basis. This will be true especially in the case of banks with low current/savings account (CASA) deposits.

The one salient feature of the policy is the strong undercurrent of an anti-inflationary stance. The RBI will stay focused on ensuring that the economy disinflates gradually and durably with CPI inflation targeted at 6 per cent by January 2016, and at 4 per cent by the end of 2017-18. Although the target for end 2017-18 is defined terms of a tolerance band of +/- 2 per cent around the mid-point, it will be the RBI’s endeavour to keep inflation at or close to this midpoint, with the extended period provided for achieving the mid-point, mitigating potentially adverse effects on the economy.

The author is a Mumbai-based economic consultant

Published on April 07, 2015

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