Millennium Post

How Rajan asserts his autonomy

The inflation rate has picked up pace for sure and inflation in November is estimated at 11.24 per cent against 10.17 per cent in October. To say the least the pace is fast and the jump is larger. Hence, the expectation is that the Reserve bank will come out with more of the same remedies, that is, a hike in interest rate.

Market analysts and bank economists offer almost a consensus view that RBI governor Raghuram Rajan will increase repo ratre by quarter of one per cent. Admittedly, the new RBI governor had stated that the central bank will take greater notice of the consumer price index in its formulation of monetary than previously. And the consumer price inflation has jumped.

The logic in conventional economics is that prices rise because there is more money in circulation. Therefore, follow a restrictive monetary policy and squeeze demand so that prices should fall. A hike in interest rate makes money costlier and therefore less credit should flow and thus demand will be curtailed. This has been happening for god knows how long. Prices, mainly food prices, were rising and the central government was raising interest rate. The circle has been repeated so many times.

But now come to think of it, will people buy less fruits (the price of which shot up) and
vegetables (inflation rate of 56 per cent) as interest rate increases. Maybe, as interest rate increases, a consumer will think twice before taking a car loan or going for financing for a TV or household gadgets. He will cut his budget for these items, if required, to meet the expenses for food. Something like might be happening. For last one year, industrial production has remained sluggish. The latest figures relating to industrial production show a contraction in output. Three major industry groups output are contracting, namely, consumer durables (-11.2 per cent), intermediate goods (-2 per cent), and capital goods (-0.2 per cent).

Thus, successive interst rate hike has successfully squeezed the demand for industrial products and their production. In line with the production trends, the prices of manufactured goods is also sluggish. Manufactured goods price inflation has remained somewhere around two per cent. But it is the consumer price index, dominated by food articles, is soaring. What is more, the price inflation is ubiquitous.  Thus, to contain food articles’ inflation should the interest rates be jacked up to such an extent and money squeeze so hard that people do not demand food? Framed like that, it sounds absurd, but the policies followed is increasingly looking like that. The disaggregated CPI inflation figures throw up certain underlying changes in the consumption from even five years back.

Firstly, while traditionally the rural CPI inflation rate used to be lower than the urban CPI inflation rate, what we are observing is that the rural CPI inflation rate is sometimes higher than urban and even in case of food items.

Thus, the rural CPI inflation rate for fruits in November 2013 was over 18 per cent in rural areas, against just above 10 per cent in urban areas. This is somewhat strange, given the fact that these are grown in rural areas and these are highly perishable. The overall CPI for rural areas is close to 12 per cent in rural areas, against 10.5 per cent in urban areas. Food and beverages taken together, rural price inflation rate was 15 per cent against urban rate of 14.5 per cent. Secondly, the earlier seasonal pattern in price trends of vegetable and fruits prices falling (sometimes collapsing) in winter months has also been broken. Prices of vegetables and fruits are rising sharply (62 per cent and 15 per cent respectively) in November. Thus, even thought the supplies of these items increase in winter months, demand is so robust that prices are rising. Significantly for these items rural price rise is strong. Therefore, rural demand is high. There could be two explanations for this new phenomenon. First, the huge infusion of funds through MNREGA is creating massive demand for food items and thus food consumption is on the rise in rural areas compared with production. This will also mean that less food is being moved out from the consumption centres to the markets thereby diminishing overall supplies.  Thirdly, informal business and activities are rising faster than captured in official statistics. Informal economy is generating larger income and therefore demand. These are generally missed in official statistics. Rather than following conventional logic, let the policy makers think afresh. Maybe, it will be better to bring experiment as well. The inflation we are experiencing is not amenable to monetary policy instruments, let us recognise that. It is primarily the responsibility of the government to contain price rise. It might be difficult to have quick fix on that. But let there be a beginning for a reasonable solution.

Raghuram Rajan is of course aware of this. He has stated this week that the state governments should scrap all restrictions on movement of food articles. Maybe, there are pockets of plenty and wider areas of shortages. If that is true, then removal of resrictions should help. However it looks like there is a jump in consumption of a variety of food items which was a more recent development. It is something to cheer about as well.

Next Story
Share it