Contrary to the widely-held perception of the markets and observers, the Reserve Bank of India (RBI) has decided not to make any changes in policy rates or ratios. The general impression was that, given the adverse numbers of the wholesale and retail price indices, the natural response would be to raise the rates.

But, as Governor Raghuram Rajan rightly pointed out, the central bank will not react to every development in a knee-jerk fashion given the data lags and the more recent episodic information available.

There seems to have been a softening in the inflation rate in the recent weeks. An obvious example is the crash in the price of onion.

What is important is the strong message coming through, both in the press release and in the interaction of the governor with the media, that the RBI is not soft on inflation. There is a reassuring statement that, if the expected fall in inflation does not take place, the central bank will take appropriate action even before the next review. Though growth is mentioned, there is not much focus on it. In fact, comfort is indirectly derived from the fact that slower growth should contribute to some relief in inflation!

There is greater emphasis on consumer prices, though for the sake of pro forma , wholesale prices are also mentioned being one of the several indicators for policymaking. I draw satisfaction from the reference to headline inflation and its cousin, namely, the one excluding food and energy. The latter is no longer called “core inflation”. For the aam aadmi , the Consumer Price Index (CPI) as a whole is the measure of core inflation, not just any part of it.

Demand and Supply I like the governor’s statement that demand has to adjust to constraints in supply. I have always argued that, in determining prices, demand and supply are like the blades of a pair of scissors.

Can anyone say which blade cuts the cloth? If there are supply constraints, the increase in aggregate demand reflected in money supply would mean that it will result in prices rising.

Incidentally, there has been so much talk about supply constraints, but no one has identified the commodities that are in short supply.

You go to the market and see plenty of foodgrains, fruits and vegetables. For those who lived through times when there was really a shortage of goods and backdoor sales taking place surreptitiously at high prices, it makes no sense to say there is a supply constraint now. That leaves only one explanation for the price rise — excessive aggregate demand.

There is a reference in the RBI press release to unseasonal upturn in vegetable prices. The time series is generally broken by analysts into four components: cyclical, seasonal, trend and random.

My guess is that the underlying trend due to the enormous increase in money supply over the years has swamped the seasonal effect. It will continue to do so unless there is a deceleration in the growth of money supply in consonance with the GDP.

Origin of Inflation The origin of inflation in the food sector, particularly vegetables and fruits, is to be traced to the tremendous rise in demand for them due to huge purchasing power created through projects such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) and the increase in wages in the industrial sector. The Government’s economists and ministers take pride in the fact that there is largescale consumption of protein-based foods.

Certainly, this is a welcome development. But the Government could have easily anticipated the outcome if it had taken measures to increase the production of protein-based foods before deciding to extend MGNREGS to the whole country. Already there is talk about raising the wages further by linking them to the CPI.

My fear is that a government that is desperate to return to power may leverage the scheme further by announcing, say, that it will be extended to 150 or 200 days in a year, in place of 100 days now, or even make two persons in each household eligible, instead of one. It could advance the specious argument that in rural areas both husband and wife work in the fields, so it is appropriate to extend the scheme to two persons.

In that case, inflation may have a field day!

(The author is a Mumbai-based economic consultant

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