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Millennium Post

When old medicines fail

There was a time when life used to be really simple, that is, in the financial sector. There would be two credit policy announcements: one for the busy season and another for the slack season, in rhythm with the agricultural seasons. Interest rates were fixed for the banks, for depositors and even for the government. At that is gone and now the interest is the king. Where money is the stock in trade – as in the financial world – interest rate is the price for it. Money is put to work at a price and the price determines your level of activity. Hence, the huge noise about interest rates at credit policy announcement.

In his first credit policy announcement the new governor has played with this price for money. The Reserve Bank is the lender of last resort and its price for money borrowed sets the pace for activities down the line. Governor Rajan has raised some kind of interest rate and raised some others and hopes that their interplay should help him achieve his goals. His primary goal at his maiden performance as the conductor of the Indian economic symphony has been to drown the noise of inflation. Admittedly, the retail inflation – measured by the consumer price index – is high. At close to double digit levels, this is a nightmare for any governor of a central banks. The traditional remedy in the governor’s medicine chest is a hike in interest rate. He has done that.

Understandable. But is it appropriate? We have seen his predecessor hike interest rates continuously for the better part of his tenure. During that time inflation has been surging upwards. Despite back to back hikes in interest rates, inflation leapt upwards. Looking into the nature of Indian inflation, it has been driven by continuous and steep hikes in food items prices. However, there have been some cycles in their movements as well. This is obvious. The prices of vegetables went up during the lean moths of the summer and they tended to soften –and sometimes collapse – during the plentiful seasons from late October to end February.

Those are the months when vegetables production –which contributed most to food price inflation – peaked. The lack of proper storage and cold chain facilities largely contributed to this cyclical price rise. There are instances when potatoes, for example, had to be thrown away as these started rotting for want of cold storages. Tomatoes meet same fate. Then there are times when prices shoot. Maybe, taking the thought to extremes, to tame vegetables price inflation and food inflation, RBI should open special windows to encourage investment in cold storages than raising a basic policy rate which pushes financial costs and affect activity. Secondly, it must also be recognised that demand for fruits and vegetables are rising with growth and development. Food habits are also changing. The need therefore is to push up production. This is beyond the ken of RBI and the government should step in for bringing food inflation under control with its programmes for enhancing production. On the other hand, the core inflation, that is, non-food manufactured goods prices, is low. These are low despite sharp fall in industrial production, meaning that off take is drastically slowing down.

If anything, for a growing economy these segments need to be given some push. Does hiking repo rates really douse inflation and inflationary expectations? Going by the facts of inflationary trends, particularly, food inflation it does not look likely. Even some of the studies indicate lack of response of prices to interest rates. Yet, orthodoxy prevails. It is also argued that had the rates not been raised, inflation would have shot up further.

It may be time for the new governor to work out an alternative policy in the light of ground realities of the Indian economy. With his background of finance and business school, he could after all be the man to bring some fresh thoughts on these issues, mixing practical approaches of a business school to monetary economics. IPA
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