Numbers don't tell inflation story

The Reserve Bank faces a big challenge — that of finalising the review of its policy for the first quarter of the year amidst misleading signals emanating from data sources.

The central bank Governor has already expressed his anguish over the situation in a recent speech. I remember a foreign statistician telling me many decades ago that India had produced great statisticians but poor statistics. The malaise continues to prevail at least in the real sector, although this is not the case with respect to the financial and banking sectors, thanks to the central bank.

There was an unexpected decline in the growth rate of industrial production to 5.6 per cent in May 2011, when experts and industry associations were expecting a better performance based on anecdotal evidence and the so-called base effect. One may not be sure of even this, because the rate for April was revised downwards from 6.3 per cent to 5.8 per cent. In the absence of reliable data on production and price trends, the formulation of policy becomes a game of blind man's buff.

INFLATION EXPECTATIONS

The news on the price front, based on the Index Numbers of Wholesale Prices, is not encouraging either. The annual inflation rate for April 2011 has been revised from the provisional estimate of 8.66 per cent to 9.74 per cent. The annual numbers for all commodities for June at 9.44 per cent (9.06 per cent in May) and food inflation of 8.31 per cent as on July 2, 2011 (7.61 per cent on June 25), are indicative of the underlying excess demand in the economy. Seasonal factors compiled by the RBI show that the peak in food prices is reached around September-October and the trough in February.

An analysis of select economic variables shows that seasonal swings have undergone a marked downward shift over the years. I have been arguing that differences owing to seasonality are in the nature of Tweedledum and Tweedledee. While this is welcome from the point of short-term policymaking, it does not support the traditional view that, come kharif or rabi season, prices will fall.

What we see is a classic example of inertial inflation where people get used to a certain rate and adapt themselves to the situation. The inflation expectation surveys of both experts and the common man testify to this. Just as an object in equilibrium can be disturbed to move to a new position only by an outside force, what is needed is a strong monetary thrust to shock the system.

SQUEEZE CREDIT

A rise of 25 basis points each in policy rates and the Cash Reserve Ratio is the least that we need to deal with the crisis. Which sections of the population will be affected? Agricultural families that constitute the bulk of the population are immune to any consequent hardship as they are protected by the rate ceiling and the provision of interest subsidy to banks by the government.

For the manufacturing sector it will mean a cut in profits. The interest element in cost of production is not significant. At the end of May 2011, non-food credit grew by 21.9 per cent year-on-year compared with 18.1 per cent a year back. Credit to industry and the service sector increased by 26.7 per cent and 21.8 per cent, respectively, as compared with 25.8 per cent and 15.0 per cent, respectively, a year earlier. Industries have availed of the less expensive external commercial borrowing as well. The year-on-year percentage credit growth in respect of NBFCs, commercial real estate and personal loans at 54.4, 19.9 and 17.7 respectively, was significantly higher than the rate of 17.5, 1.2 and 5.6, respectively, recorded at the end of May 2010. Personal loans for consumer durables, housing and vehicles registered accelerated growth. They can all do with some deceleration in bank advances.

The time is opportune for the RBI to formulate a tighter monetary policy without bothering itself about data limitations. Persistent inflation is a fact borne out by the daily experience of millions of people. Government also agrees on the need to sacrifice growth in the interests of price stability, which benefits all, unlike the former that is skewed in its impact.

GOVERNOR'S TENURE

We are living in very difficult times and there is a great need for continuity in the positions of policymakers. The RBI Governor will complete his three-year term in September.

It has been a difficult period for him and the economy right from the beginning and he has earned plaudits for his management both from within the country and from international institutions. In an unprecedented gesture, three distinguished ex-Governors are reported to have appealed to government to keep him in the post for another term. Since the 1980s, the central bank has followed a convention of filling the four Deputy Governor posts with an economist, banker and a member each of RBI staff and the IAS.

Whenever the Governor is from the IAS, the quota for that service is released for the benefit of the RBI staff. Recently, the RBI staff got a second DG from their ranks. The government might have taken a decision in principle to extend the term of the Governor, who is from the IAS. There seems to be no other contender from that service as of now.

(The author is a Mumbai-based economic consultant. blfeedback@thehindu.co.in )

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