EVALUATING RAJAN

No matter what the criteria, inflation has dropped by a large magnitude during Raghuram Rajan’s tenure as Governor

No matter what the criteria, inflation has dropped by a large magnitude during Raghuram Rajan’s tenure as Governor

Governor Raghuram Rajan presided over his last monetary policy meeting on August 9. He demits office on September 5, three years after he assumed control over Indian monetary policy. There will be, and there should be, several articles examining his performance as RBI Governor. This is my first.

And in this first evaluation, I will examine his performance in stabilising India’s macro-economy. Possibly, the most important function of any monetary authority is control over inflation, so critical a function that India has legally adopted the system of inflationtargeting. In the future, if inflation deviates from the target, RBI will have to report to Parliament as to the reasons why it has missed the target, and what remedial policy it was adopting.

Inflation control had functioned very well without inflation-targeting in India. It is now conveniently forgotten (especially by the UPA government) that rural inflation (represented by CPI for agricultural laborers) registered an annual rate of only 4.2% between June 1996 and May 2004. The end-points represent the departure of the Congress-led government and the installation of three different nonCongress prime ministers. During the same time period, urban inflation (represented by CPI for industrial workers) registered an average rate of 5.8%. A simple average of the two yields a 5% average inflation.

Then along came the UPA government and with them, the quest for 273 seats in Parliament. What is the link? The belief that the rural vote could be bought via large increases in the minimum support prices (MSPs) for major crops like rice, wheat and sugar. Hence, in a time-period (June 2006 to May 2014) when the median developing country inflation stayed constant at around 5%, rural inflation galloped to an average of 8.6% per annum, and urban inflation at 8.2%!

In September 2013, CPI inflation (hereafter, the inflation figures refer to the joint urban and rural CPI series) was 10.5% and Rajan had a Volckeresque task ahead of him, i.e., eliminating generalised inflation from the system and bring the system back to the pre-UPA normal, i.e., low overall inflation with occasional spikes in individual items like onions or pulses, etc.

Median developing country inflation has declined from 5.1% in 2013 to around 3.5% at present. So, the enabling international environment has been positive for declines in inflation. However, since September 2013, the price of imported crude oil dropped from R6,700 a barrel to R3,290 a barrel (as of June 2016); but, the Indian consumer hasn’t seen much of the decline. The CPI index for petrol reduced from 112 to 95— just a 17% decline. Note that the price of pulses (with a near identical importance in the CPI as petrol) during this period increased from 106 to 174—a 64% increase. In other words, to point to the oil price decline as a major, or even a minor contributor, to the CPI decline in India under Rajan is to make an error of mammoth UPA (or IMF?!) proportions.

To be sure, international commodity prices have also weakened during Rajan’s tenure, but what has happened to commodity prices in India is currently being researched by me (and I am sure several others).

How well Rajan has done in reducing inflation in India is shown in the accompanying graphic for seven categories All items of consumption. The reader (or policymaker) can choose her yardstick. The third column of the table is the year-onyear (y-o-y) inflation in September 2013; the fourth column is the y-o-y inflation in June 2016 (latest data available). The fifth column is the decline in percent. For example, overall inflation in June 2016 was 5.7% compared to the starting point of 10.5%, i.e. representing a decline of 45.7%.Summary of the results: No matter what the criteria, inflation has dropped, and dropped by a large magnitude between September 2013 and June 2016. Further, the decline is constant across the major groups and close to half the inflation level recorded in September 2013. Overall inflation— almost halved, or a reduction from 10.5% to 5.7%. Similar halving in the volatile category of fruits, pulses, and vegetables (FPV). What about food excluding FPV? Today, this “high inflation” category is inflating at just 4.9%. Core inflation, or inflation excluding food and fuel? Just 4.5%—a large reduction from 7.8% in September 2013. Finally, I report an inflation number for 88.7% of all goods in the CPI, i.e., all goods minus the price inelastic and price volatile perishables, FPV. Somewhat surprisingly, this broadest measure of inflation reports a 4.5% value—the same as the popular core index of inflation.

Thus, no matter how one looks at the figures, Rajan’s record in reducing inflationhasbeenspectacular.Tobesure,this reduction was possible because of the “beautiful friendship” (see Casablanca) that evolved between RBI (Rajan), the ministry of finance (Jaitley) and prime minister Modi. It was a friendship that many thought was “permanent” and could not be brought down—except, tragically, by dirty politics.

But the inflation buck stops with Governor Rajan. While the government deserves some credit, the fact remains that this extraordinary inflation decline observed in India would not have been possible without Rajan’s leadership and his (correct) singleminded obsession with returning inflation to normal in India. As the graphic shows, even food excluding FPV has an inflation rate of only 4.5%. FPV inflation is likely to decline postOctober, when the monsoon effects on perishables' prices will begin to more than trickle in. If FPV inflation for a few months is zero (let alone negative), overall headline inflation will register 4%, not the 5.7% observed at present.

That will mean that inflation under Rajan is one-third the level he inherited, and one-third at a very respectable level of 4%. The financial world had wondered whether it will ever see the likes of Volcker again—he reduced US CPI inflation from 13.5% in 1980 to 6.2% in 1982 and 4.4% in 1984. What did help Volcker enormously was the decline in the price of crude oil—25%, from about $40 a barrel in May 1980 to about $30 a barrel some three to four years later. This luxury, as documented above, was not available to Rajan. The international oil price decline was taxed in India, a correct policy and one fully supported by Rajan.

Rajan will go back to the world of ideashavingleftthemacro-economyina very sound condition. Thank you, Rajan—India will miss you, and your ideas. The author is contributing editor, The Financial Express and senior India analyst, The Observatory Group, a New York-based macro policy advisory group. Twitter: @surjitbhalla