Price Pangs
The danger of rising retail inflation slowing down the interest-rate-easing cycle is real.
The danger of rising retail inflation slowing down the interest-rate-easing cycle is real
In July, wholesale price index ( WPI) zoomed to a two-year high at 3.55 per cent after staying in the negative zone for 17 months. The sudden burst in WPI is not good news for the economy as it would eventually show up in the consumer price index (CPI), or retail inflation numbers. This, despite the fact that the July CPI at 6.07 per cent is nowhere near the RBI’s comfort zone, given that the central bank is single mindedly pursuing an inflation target of 4 per cent, plus-orminus 2 per cent for the next five years.
Clearly, the gradual upsurge in inflation numbers is expected to slow down the pace or, at best, put a status quo
on the interest- rate- easing cycle this year. Under Raghuram Rajan’s tenure, inflation had eased from 10 per cent-plus to 6 per cent. This gave Rajan room to cut the repo rate from 8 per cent to 6.5 per cent.
Now, it may be very difficult to reduce retail inflation from 6 per cent to 4 per cent. Low and stable inflation is necessary to reduce interest rates and support economic growth. But, historically – at least in the past 15 years – retail inflation was never stabilised at 4 per cent. And, as in the past, the main culprit was food inflation.
According to a recent report on food inflation by State Bank of India’s economic research department, inflation has mostly remained over 4 per cent since independence. Between 2000 and 2007 – the period that witnessed buoyancy in both the global and Indian economies – India’s average CPI was 4.6 per cent. But as the world economy headed for a recession in early-2008, the CPI averaged close to 10 per cent. It was only in 2014 that retail inflation started its downhill journey from 10 per cent to around 4 per cent. Now, CPI is again headed north after touching 4.83 per cent in March. (see Rearing Its Ugly Head).
“It is going to be a big challenge in bringing down inflation to 4 per cent,” former RBI governor D. Subbarao told Business Today in a recent interview. During most part of his tenure, when WPI used to be the benchmark for setting inflation targets, Subbarao had kept the rates high to tame inflationary pressures. He reasoned that inflation in Indian is driven more often by supply-side pressures. “If any improvement in their (Indian middle-class) income takes place, it quickly translates into demand and puts pressure on (retail) inflation,” says Subbarao. In fact, this is often at display during general elections when demand for cash goes up abnormally, followed by consumption.
SBI Chairperson Arundhati Bhattacharya believes supply-side issues are a major roadblock for achieving the 4 per cent target. “It cannot be fixed alone by reducing money flow,” she says. The RBI, on its part, says there are discretionary items in the food basket that can be controlled by hiking policy rates. “Food inflation needs a number of fiscal measures. It is important for the government and the RBI governor to work in collaboration to bring inflation down from 6 per cent to 4 per cent,” adds Bhattcharya.
To contain food inflation, the Centre’s intervention is very important. Likewise, fiscal deficit has been a major hindrance in the way of lowering inflation to a targeted level. The previous government had enacted the Fiscal Responsibility and Budget Management Act (FRBM) in 2003 with a target of 3 per cent fiscal deficit by 2009. The deadline was pushed back several times, primarily due to the much-needed fiscal stimulus packages in the post-2008 period.
The Urjit Patel Committee, which recommended inflation targeting, was of the view that the central government’s earlier fiscal deficit goal of 3 per cent of gross domestic product by 2016/17 was not only necessary, but achievable. However, India is still far away from the target and, in fact, the government was forced to revise it to 3.5 per cent. The massive push towards infrastructure and agriculture in Budget 2016/17 could further push the number up if the revenue targets fall short.
Last but not the least, are the populist schemes that contribute to inflationary pressures. Take, for instance, the Mahatma Gandhi National Rural Employment Guarantee Scheme ( MGNREGS), which remains an important programme even for the present NDA government, or the National Food Security Act. MGNREGS has put immense pressure on wages in rural India as people are not available for work in factories, and are happy to get their 100 days of employment under the scheme. Similarly, the food security scheme puts huge pressure on demand for food grain. ( see Playing Spoilsport).
But there are some who are optimistic. Naresh Takkar, Mana-ging Director and Group CEO at rating agency ICRA, says though retail inflation for July exceeded the upper tolerance level, favourable base effect, and improved monsoon and kharif sowing dynamics would bring inflation down.
Now, it is up to the six- member Monetary Policy Committee and the next governor to take a call on interest rates at the first meet on October 4. ~