Global inflation and India Most analyses of accelerating inflation in India emphasise the role of “importedinflation” in driving Indian prices upwards. In this edition of Macroscan, C. P. Chandrasekh ar and Jayati Ghosh examine the trends in global markets that influence domestic price movements and their i mplications. With the annual rate of inflation in India having touched 7 per cent on a point-to-point basis during the week-ending March 22, 2008, the search for policies to combat the price rise has begun. One factor seen as making that search difficult is the ostensible role of “imported inflation” in dri ving the rise in domestic prices. There is an obvious reason why such an argument arises. Among the products primarily responsible for the current inflation are f ood products of different kinds, including cereals, intermediates like metals and the universal intermediate, oil.
Most analyses of accelerating inflation in India emphasise the role of “imported inflation” in driving Indian prices upwards. In this edition of Macroscan, C. P.Chandrasekhar and Jayati Ghosh examine the trends in global markets that influence
domestic price movements and their implications.
With the annual rate of inflation in India having touched 7 per cent on a point-to-pointbasis during the week-ending March 22, 2008, the search for policies to combat theprice rise has begun. One factor seen as making that search difficult is the ostensiblerole of “imported inflation” in driving the rise in domestic prices.
There is an obvious reason why such an argument arises. Among the products primarilyresponsible for the current inflation are food products of different kinds, includingcereals, intermediates like metals and the universal intermediate, oil.
Of these, the difficulties that high and rising levels of oil prices pose have been knownfor some time now. Price movements for the two varieties of crude that enter India’simport basket (Chart 1) show that since May 2003 international prices have, despitefluctuations, been on a continuous rise. In the event the prices per barrel of thesevarieties have moved from less than $25 in May 2003 to close to or well above $100today.
Real price of oil
This has changed one feature of the oil price scenario that held during much of the lasttwo decades. During those years, despite high nominal prices, the real price of oil
(adjusted for increases in the general price level) was far lower than that whichprevailed during the 1970s. As Chart 2 shows, when measured by the price-deflated
refiner acquisition cost of imported oil in the US, in the years since 1974 the real priceof oil was higher than that in 2006 only during a brief period between 1980 and 1982.Since 2006, nominal oil prices having risen further at rates much higher than theaverage level of prices.
As a result, oil producers are regaining the real price benefits they garnered during the1979-81 shock. According to one estimate, in terms of current prices, the late 1970s-early 1980s peak in oil prices works out to $100-110 a barrel. That is a figure that weare fast approaching.
Underlying the buoyancy in prices is the closing gap between global petroleum demandand supply at a time when the spare capacity is more or less fully utilised. Much of theincrease in demand is coming from China, but that is affecting stockpiles everywhere.This trend, combined with the uncertainty in West Asia resulting from the occupation of Iraq and the standoff in Iran, has created a situation where any destabilising influence— such as political uncertainty and attacks on the oil supply chain in Nigeria — triggersa sharp rise in prices.
What needs noting, however, is that prices are where they are because speculatorshave exploited these fundamentals. It is known that energy markets have attractedsubstantial financial investor interest since 2004, but especially after the recent declinein stock markets and in the value of the dollar. Investors in search of new investmenttargets have moved into speculative investments in commodities in general and oil inparticular. The Organisation of the Petroleum Exporting Countries (OPEC), which isnormally held responsible for all oil price increases, has repeatedly asserted that oil hascrossed the $100-a-barrel mark not because of a shortage of supply but because of financial speculation.
Views similar to those from OPEC have been expressed by more disinterested sourcesas well. As far back as April 29, 2006, The New York Times had reported that: “In thelatest round of furious buying, hedge funds and other investors have helped propelcrude oil prices from around $50 a barrel at the end of 2005 to a record of $75.17 onthe New York Mercantile Exchange.”
According to that report, oil contracts held mostly by hedge funds had risen to twice theamount held five years ago. Such transactions are clearly speculative in nature.
While the disruption caused by the US occupation of Iraq, other geopolitical factors andthe speculation that followed have played a role in the case of oil, what explains therecent increase in other global commodity prices, especially food articles and metals?Chart 3 (based on IMF data) shows that, except for agricultural raw materials whoseprices have increased very little, all the other commodity groups have shown sharprises in price.
The rise in price levels for metals was the earliest in the recent surge, with theweighted average of metals prices increasing sharply from the last quarter of 2005, and
almost doubling in the two-year period to February 2008. Coal prices more thandoubled last year, thereby showing a faster rise than even the oil price. Food prices,like agricultural raw materials, had shown only a modest increase until early 2007. Butsince then they have zoomed, such that the IMF data show more than 40 per centincrease in world food prices over 2007.
Food price index
The FAO food price index, which includes national prices as well as those in cross-border trade, suggests that the average index for 2007 was nearly 25 per cent abovethe average for 2006. Apart from sugar, nearly every other food crop has shown verysignificant increases in price in world trade over 2007, and the latest evidence suggests
that this trend has continued and even accelerated in the first few months of 2008. Thenet result is that globally the prices of many basic commodities have been rising fasterthan they ever did during the last three decades.
It has been argued that these developments are largely demand driven, being theresult of several years of rapid global growth and the voracious demand from somefast-growing countries such as China. Certainly there is some element of truth in this.And to the extent that this is true, it implies that the world economy is heading back tothe late-1960s and early-1970s scenario wherein rapid and prolonged growth came up
against an inflationary barrier. Capitalism’s success over the last two decades was itsability to prevent such an outcome, political economy processes that restrained the
wage and income demands of workers and primary producers. But clearly there arelimits to such a process, and these limits are now being reached.
If this were the only cause of the recent commodity price inflation, it would not
necessarily be of such concern to policymakers, because it could then be expected thata slowing down of overall growth would simultaneously reduce inflation. It would alsoreflect some recovery of the drastically reduced bargaining power of workers andprimary producers. But there are other, more worrying tendencies in operation, thatsuggest that the current global inflationary process has other factors pushing it whichwill not be so easily controlled.
Forces behind the rise
To understand this, it is necessary to examine the forces behind the price rises fordifferent commodities. In the case of food, there are more than just demand forces atwork, although it is certainly true that rising incomes in Asia and other parts of the
developing world have led to increased demand for food. Five major aspects affectingsupply conditions have been crucial in changing global market conditions for food crops.
First, there is the impact of high oil prices, which affect agricultural costs directlybecause of the significance of energy as an input in the cultivation process itself (through fertiliser and irrigation costs) as well as in transporting food. Across the world,
governments have reduced protection and subsidies on agriculture, which means thathigh costs of energy directly translate into higher costs of cultivation, and therefore
higher prices of output.
Second, there is the impact of both oil prices and government policies in the US,
Europe, Brazil and elsewhere that have promoted bio-fuels as an alternative topetroleum. This has led to significant shifts in acreage as well as use of certain grains.
For example, in 2006 the US diverted more than 20 per cent of its maize production tothe production of ethanol; Brazil used half of its sugarcane production to make bio-fuel,
and the European Union used the greater part of its vegetable oil production as well asimported vegetable oils, to make bio-fuel. This has naturally reduced the available land
for producing food.
Policy neglect
Third, the impact of policy neglect of agriculture over the past two decades is finallybeing felt. The prolonged agrarian crisis in many parts of the developing world; the
shifts in acreage from food crops to cash crops relying on purchased inputs; theexcessive use of groundwater and inadequate attention to preserving or regeneratingland and soil quality; the lack of attention to relevant agricultural research andextension; the overuse of chemical inputs that have long-run implications for bothsafety and productivity; the ecological implications of both pollution and climatechange, including desertification and loss of cultivable land: all these are issues that
have been highlighted by analysts but largely ignored by policymakers in mostcountries.
Reversing these processes is possible but will take time and substantial publicinvestment, so until then global supply conditions will remain problematic.
Fourth, there is the impact of changes in market structure, which allow for greaterinternational speculation in commodities. It is often assumed that rising food prices
automatically benefit farmers, but this is far from the case, especially as the global food
trade has become more concentrated and vertically integrated.
A small number of agribusiness companies worldwide increasingly control all aspects of cultivation and distribution, from supplying inputs to farmers to buying crops and even
in some cases to retail food distribution. This means that marketing margins are largeand increasing, so that direct producers do not get the benefits of increases expect with
a time lag and even then not to the full extent. This concentration also enables greaterspeculation in food, with more centralised storage.
Financial speculators
Finally, primary commodity markets are also attracting financial speculators. As theglobal financial system remains fragile with the continuing implosion of the US housingfinance market, commodity speculation is increasingly emerging as an importantalternative investment market. Such speculation by large banks and financialcompanies is in both agricultural and non-agricultural commodities, and explains atleast partly why the very recent period has seen such sharp hikes in price.
Commodity speculation has also affected the minerals and metals sector. For thesecommodities, it is evident that recent price increases have been largely the result of increased demand, especially from China and other rapidly growing developingcountries, but also from the US and European Union.
A positive fallout of the recent growth in demand and diversification of sources of demand is that it has allowed primary metals producing countries, especially in Africa,to benefit from competition to extract better prices and conditions for their minedproducts. But there is also the unfortunate reality that higher mineral prices have rarelyif ever translated into better incomes and living conditions of the local people, even if
they may benefit the aggregate economy of the country concerned.
At any rate, metal prices are high and likely to remain so because of the growingimbalance between world supply and demand. A reduction in global output growth rateswould definitely have some dampening effect on prices from their current highs, but thebasic imbalance is likely to continue for some time. This is also because there has beena neglect of investment in this sector as well, so that building up new capacity will take
time given the long gestation period involved in investments for metal production.
Implications for India
So the medium-term outlook for global commodity prices, while uncertain, is that theyare likely to remain high even if the world economy slows down in terms of outputgrowth. What does this mean for India? Until the 1990s, both producers and consumersin India were relatively sheltered from the impact of such global tendencies because of
a complex system of trade restrictions, public procurement and distribution and policyemphasis on at least food self-sufficiency.
The liberalising policies that began in the early 1990s have rendered all of that history,since one explicit aim of the reform strategy was to bring Indian prices closer in line to
world prices. Countries like India seeking to manage this effect of global speculation on
the prices of a universal intermediate like oil have to decide how important it is toinsulate the domestic economy and the domestic consumer from its effect.
Given the huge revenues being derived from duties on oil products, one way this can be
done is to forego duty while holding oil prices. This would require compensating forrevenue losses with taxes in other areas which a growing economy can contemplate.
But the Government appears unwilling to take this route, increasing pressure to hike oilprices further and aggravate an inflationary tendency that is already proving to beeconomically and politically damaging.
Ineffective strategy
This reticence till recently to proactively insulate the domestic economy has meant, thatboth producers and consumers are now more or less directly affected adversely byglobal trends.
The Government’s response to the domestic price rise, which is already creating panicin official corridors in an election year, has been to reduce or eliminate import duties onseveral food items such as edible oils, so as to allow imports to bring the price down.
But that is a short-sighted and probably ineffective strategy. It provides directcompetition to Indian farmers producing oilseeds, even as they suffer rapidly risingcosts. It sends confused signals not only to farmers for the next sowing season, but
also to consumers, and leaves the field open for domestic speculators as well becausethe imports are not under public supervision but left to private traders.
Most of all, given the tendency of international commodity prices noted here, it will notsolve the basic problem of rising inflation in such commodities. Instead, it will make theIndian economy even more prone to the volatility and inflationary pressure of worldmarkets. In fact, the increases in prices in India have not been as sharp for somecommodities largely because of the vestiges of the intervention era.
Thus, prices of some commodities, like rice for example, have gone up less than worldprices only because exports have been prohibited. This does suggest that the Indianeconomy cannot hope to remain insulated from these global trends without much more
proactive policies that rely substantially on government intervention in several areas.
In the case of food, this essentially requires a more determined effort to increase theviability of food cultivation, to improve the productivity of agriculture through publicmeasures, and to expand and strengthen the public system of procurement anddistribution.
For other commodities too, it is now evident that a laissez fairesystem is simply notgood enough, and public intervention and regulation of markets is essential.
Double-digit inflation grips large parts of rural India
Close to 20% in 10 States in December; Kerala's rate is lowest.
The trend of high inflation across States goes to suggest that larger, as opposed to region-specific factors, are at work. While the price rise was uniform across regions in rural areas, it varied more sharply from town to town inurban India.
A. Srinivas
Bangalore, Feb. 5
All major States, with the exception of Kerala, are in the grip of double-digit rural inflation, with the western and north-western States in the lead.
Rural India experienced a particularly sharp rise in prices between September and December this fiscal.
While rural India presents a picture of uniform price rise across regions, with even poor States such as Bihar andOrissa recording 15 per cent inflation in December 2009, the price rise in urban India varies more sharply from townto town.
Rural Tamil Nadu, Kerala and Karnataka were the only major States that posted double-digit inflation in 2008-09, asmeasured by the consumer price index for rural labour, in which food items have a weight of 67 per cent.
The all-India inflation rate for rural labour was 7.8 per cent in 2008-09.
Gujarat recorded the lowest rate of CPI-RL inflation in 2008-09, at 5.4 per cent. Kerala's rate of rural inflation, at 9.3per cent in December 2009, is the lowest among major States.
All-India rural inflation was 17 per cent in December 2009, measured on a year-on-year basis, sharply up from 12.7per cent in July 2009. The rate of inflation, measured year-on-year, climbed from 13 per cent in September to 17 per cent in December.
The rate of rural inflation was close to, or above, 20 per cent in December in Rajasthan (22 per cent), Gujarat (21 per cent), Maharashtra (21 per cent), Haryana (20 per cent), Punjab (20 per cent), West Bengal (18 per cent), Karnataka(18 per cent), Madhya Pradesh (18 per cent), Uttar Pradesh (18 per cent) and Assam (17.5 per cent).
The States, apart from Kerala, that posted lower rates of inflation in December than the all-India average are Bihar (14.7 per cent), Orissa (14.6 per cent), Andhra Pradesh (16 per cent) and Tamil Nadu (14 per cent).
The States that recorded a particularly sharp rise in the yera-on-year inflation rate between July and December areRajasthan (13.6 per cent to 21.6 per cent), West Bengal (10.8 per cent to 18.2 per cent), Uttar Pradesh (9.6 per cent
to 17.8 per cent), Maharashtra (15 per cent to 21 per cent), Haryana (13 per cent to 20 per cent), Assam (12.5 per cent to 17.5 per cent) and Punjab (12.5 per cent to 20 per cent).
Kerala's rate of inflation fell from 10.2 per cent in July 2009 to 8.8 per cent in October and climbed to 9.3 per cent inDecember.
Likewise, the inflation rate in Madhya Pradesh dipped a bit between July (15 per cent) and October (14 per cent), butrose sharply in November and December. Orissa, too, posted a drop between July and September.
The rise was relatively moderate (3 to 4 percentage points) over the six-month period in Bihar, Tamil Nadu, MadhyaPradesh and Karnataka.
The trend of high inflation across States goes to suggest that larger, as opposed to region-specific factors, are atwork.
While the Consumer Price Index for Industrial Workers (in which food has a weight of 46.2 per cent), rose 13.5 per cent in November 2009 over the same period in 2008, the rise in seven cities – Guntur, Vijayawada, Monghyr-Jamalpur, Bhavnagar, Vadodara, Jamshedpur and Mysore – varies from 4.9 per cent (Guntur) to 19.3 per cent(Vijayawada).
The price rise of individual food items, save pulses, varied sharply from one place to the next. If meat and fish pricesin Mumbai were up 5 per cent and 12 per cent, respectively, in October 2009, the rise was 21 per cent and 66 per cent in Surat, 24 per cent and 44 per cent in Hubli-Dharwar, and 17 per cent on both items in Bhilai.
In many of these towns, the price rise was higher in October 2008 in the case of these two items. Rice prices were upover 20 per cent in most major towns in October 2009.
Inflation concerns
Instead of addressing the real cause of inflation that is rampant, leading to profiteering and illegal hoarding at themiddlemen levels, the Indian consumer is being blamed incredulously.
It is felt that since the consumer is able to afford the high prices of food, the level of inflation is justified. Further, theauthor justifies the high food and other essentials' inflation on the grounds that “…There's no consumer resistance”and goes on to suggest that “impounding (say) 10 per cent of salaries above a certain level in Government and theorganised sectors” could be the possible solution to the problem.
Though the prices of grains, vegetables, meat and dairy products are soaring, at the retail level, the common man isleft with little option but to buy them at whatever prices they are available? One has to eat and feed one's family,whatever the cost may be. Or, should he starve for a few days (just like the good old days of socialism) to register his“resistance to the price rise”?
As for the impounding suggestion, the less said the better. Besides non-monetary aspects of inflation, the solution tothe problem lies in better governance and improved checks and measures to ensure that the supply chain is fair andtransparent to both the consumers and the producers. Also, middlemen should function as facilitators and not asmarket manipulators.
When inflation perpetuates itself A. Seshan
The inflation rate may have developed a kind of ‘inertia', where people get used to a higher level. A market shock,such as release of foodgrains at below market rates, can help break this inertia.
As expected by the market and observers, the Reserve Bank of India (RBI) has tightened its monetary policy. TheRepo and Reverse Repo rates have been raised by 25 basis points and 50 basis points, respectively. The immediatereaction of the stock market was somewhat subdued as the measures had been factored in.
Economic astrologers, both official and non-official, have made forecasts on GDP growth and the course of inflation.The latest is that the inflation rate will fall after the kharif rain. Well, if that does not happen, there is always the rabiseason. Perhaps only Paul, the octopus in Germany, can choose the correct prediction!
‘INERTIAL' INFLATION
In the current discussions in India, a concept that is conspicuously missing is ‘inertial inflation'. Inertia is a term fromPhysics used in Economics, like velocity, acceleration, etc. Inertial inflation refers to a situation when the rate of priceincrease attains a stable equilibrium, where it remains unless a shock is administered to move it to a new one.
The Economics Study Guide accompanying the textbook of Economics by Samuelson-Nordhaus says: “The inflationrate itself has some inertia — that is a tendency not to move unless pushed — only because prices have a consistentmomentum that translates into a stable rate of increase… Individuals expect it and the expectation tends to become
self-fulfilling prophecies…
Either demand-pull or cost-push inflation can contribute to inertial inflation, the best reflection of which is asimultaneous shifting of both the aggregate supply and the aggregate demand curves.”
BREAK THE LOG-JAM
Looking at the double-digit inflation in the recent months, with the rate relating to primary articles persisting at around15 per cent, one wonders whether we are in a state of inertial inflation. Considerable research has been done in thisfield in other countries, especially in relation to Brazil. However, no consensus has emerged on the validity of thehypothesis. But it is a fact of life that people get used to a certain rate of inflation and their decisions on economicactivities are determined accordingly. The central bank has also done its bit to promote inertial inflation bypropagating the view that a steady 5-per-cent inflation year after year (now 4.0-4.5 per cent) is what the doctor hasprescribed for the economy's ills!
The only way to break the log-jam of inertial inflation, if any, and bring down prices, particularly those of primaryarticles, is to administer a shock to the market.
This can be done by making available, to all citizens, the abundant Government stocks of wheat and rice at asubstantial discount to the market price. It will not affect the wheat farmer as he has already sold his stocks at goodprices. It won't affect the rice farmer either in the oncoming kharif season as he is assured of a good procurementprice.
Only the middleman who has a vested interest in the rising prices of his stocks will suffer, but no one sheds tears for him. The government should undertake a cost-benefit study of selling stocks at a suitable discount to market prices,by taking into account what it saves by avoiding storage charges, interest, spoilage, pilferage, etc., and decide on theamount of fiscal deficitit can afford to incur. The success of the telecom licensing scheme provides a substantialmargin to the government to adhere to its deficit target even after implementing the scheme mentioned above.Recently, the Prime Minister's Economic Advisory Council also recommended the sale of stocks at below-marketprices.
FARM PRICE POLICY
What does not seem to be appreciated is the need for a harmonised agricultural price policy that goes well with anti-inflation measures. Farmers are used to seeing support prices go up year after year, even against therecommendations of the Commission for Agricultural Costs and Prices. This gets built into inertial inflation.
In the West, only farmers are subsidised. But in India we have subsidies both for farmers and consumers. There isthe anomaly of rice and wheat being provided to the BPL families at Rs 3 per kg and the poor farmer paying Rs 10per kg of fodder! There is a gradual shift from mechanical to manual harvesting in Punjab and Haryana, thanks tobetter recovery of fodder. This has led to delays in completing harvests and market arrivals, with the consequenteffect on prices.
Despite the existence of so many agricultural universities patterned after the model of Land Grant Colleges in US,there is no evidence of a breakthrough in the productivity of many crops. Either the R&D efforts are inadequate or extension agencies are not taking results to farms.
About a half century ago Prof Earl Heady of Iowa State University in Ames, US, told me that a doctoral thesis by anIndian student showed that, without any increase in resources, farm output in India could be increased by 10 per centby rearranging crop patterns in different regions to exploit comparative advantages in productivity. We have theintellectual and research resources to bring about another Green Revolution. What is lacking is political leadership.
Inflation: Time for non-monetary solutions?
The Quarterly Monetary Policy Review has come and gone. The Reserve Bank of India duly raised rates a quarter point.
Are we closer to the beginning or end or somewhere midway in the up cycle of interest rates? The general opinionseems to be that we do have some way to go, considering that the increases so far haven't brought down inflation asmuch as we want.
Officialdom keeps saying food inflation will be down to five-six per cent levels on the back of good rains and harvestsand their flow into markets. But a recent story in ‘Business Line' makes the important point that supply increases havebeen immediately reflected in a fall in wholesale prices, but not for the consumer. Not that the retailers have formed acartel. There's no consumer resistance.
The job market is booming and nominal incomes are rising sharply. The large discretionary incomes with the middleclass upwards make them price insensitive to the cost of living. The savings ratio of these segments could be over 50
per cent. Besides, their investments in property and stocks have paid off handsomely, adding substantial wealth toalready high incomes.
There's enough liquidity in banks, despite the transfer of funds to Government after the spectrum auctions. This isbecause they have invested more than the mandatory 25 per cent in Government securities. The excess is eligiblecollateral to borrow from the RBI itself.
With Government bond yields in the region of 7 per cent, holding more Government securities than necessary is notonly costless, it's profitable, because the RBI charges only the repo rate of 6 per cent on its lending against theGovernment collateral. The central bank can be arbitraged against itself!
Credit is easy, cheap relative to general inflation and more so relative to asset prices.
Taking into account all of the above, do we have the makings of a bubble? That's the big question for the centralbank.
On the monetary front, the pressure on the RBI will be relentless. Soon, if not already so, banks will turn liquiditysurplus. Money rates will descend well below the repo rate. Another round of CRR increases is on the anvil to tightenliquidity and ‘manage' market interest rates.
Are non-monetary solutions in order?
How about impounding (say) 10 per cent of salaries above a certain level in Government and the organised sectorswithout paying interest for a period of (say) one year?
That could ratchet down the optimism factor that's ratcheting up inflation.
RBI is missing the problemAshok Upadhyay
The RBI's latest signals will merely spike interest rates without actually containing inflation. It has taken no specific steps to curb speculative activity in housing, one of the principal drivers of the price rise.
The real estate and housing market has all the ingredients of speculative overheating.
The day after the first quarter monetary policy review was announced on July 27, media reports quoted bankershinting that lending rates would not go up before October, even though many would consider raising short-termdeposit rates. A few days later, their perspectives had changed; bankers from the public and private sectors sounded
more certain about spikes in both deposit and lending rates.
Mr Bansal, Executive Director, United Bank of India, was not just sure about the hikes, but also about the burdenbeing passed on to the borrower. Why not? Banks had had the time to read the report carefully enough to be certainof their responses.
The message had been imbibed. The Reserve Bank of India wanted banks to raise rates — deposit rates because itwould help them to replenish their declining stock of funds that have been moving into more lucrative avenues, andlending rates because the central bank wished to skim off excess demand, and what better way to do that than toraise the cost of borrowing?
And as if to leave no room for doubt, Dr Subir Gokarn, the newest Deputy Governor, made it clear that banks wouldhave no choice but to pass on the rate hike to the borrower. Interest rates will rise sooner than later because the‘transmission mechanism' between the RBI and banks works far better for rate hikes than the other way around.Before the RBI began tightening the screws in January, one of its repeated observations was on the “transmission”mechanism that impeded the communication of its easy monetary signals.
ECONOMY UP, ANYWAY
In its April review for instance, the central bank noticed from data of select banks that the weighted average yield onadvances which is a proxy for “effective lending rates” was expected to decline from 10.8 per cent in March 2009 (atime of an accommodative money policy) to 10.1 per cent 12 months later. That's hardly an easy money regime.
Despite the double digit average interest rate the organised economy perked up, slowly but surely, for two reasons:global funds for companies with a good track record and a buoyant equity market enabled them to raise cheaper funds than were available from banks, a preference that partly accounted for the slow credit growth during the start of the recovery phase and its consolidation.
Second, the fiscal stimulus and the Sixth Pay Commission awards that re-launched the economy by encouragingconsumer spend on durables.
Once the recovery had begun, nothing that the RBI did since January with its persistent hikes in key rates or CRRmade a difference. Why? Because, both producers and consumers had never known a low interest rate regime; evenduring the slowdown, India had the highest interest rates in the world, a fact that encouraged the first flush of capitalflows after Western governments had pump-primed their banks.
Odds stacked against it
The RBI's monetary policy intervention has all the odds stacked against it; its easy money policy did not introducecheaper funds into the economy when needed and its rate hikes may not dampen excessive demand or, morecritically, dampen prices. All through the period of steady rate hikes since January, inflation measured either as theheadline (or WPI) or CPI rose steadily; prices moved in inverse proportion to monetary tightening and key rate hikes.
The current inflation began with rising food prices and has become more “generalised”, to use the RBI term for acontagion. Prices of non-food manufactures rose from less than 1 per cent in November 2009 to 5.4 per cent in
March this year and 7.4 per cent in June; in the event a case could be made that choking off easy money to thesector could check the contagion.
That case would stand only if the RBI had taken into account every sector with inflating prices, that is, every sector suffering from a demand-supply gap and other distortions. But the central bank has no account of how prices in theservices sector have been moving and have they been moving up at a dizzy speed!
The real estate and housing market has all the ingredients of speculative overheating; shortages in land and housingunits have pulled up prices and the distortions in the land market, in land acquisitions for instance, have perpetuatedthe rise.
The demand for housing has now entered the speculative phase with “lifestyle complexes” attracting savings andexternal capital flows for purely investment gains.
SPECULATIVE ACTIVITY
The National Housing Bank's “Residex” cannot capture this phenomenal escalation in real estate prices, nor does theWholesale Price Index with which the RBI sets its monetary policy, because the metric does not consider anythingthat is not a commodity you can hold in your hand.
The CPI for urban non-manual employees (CPI-UNME) gives us some clue: for May the housing index rose 33 per cent as against the food metric that rose just 14 per cent. While this is a crude measure of how prices are moving in
one of the neglected epicentres of inflation, there can hardly be any doubt that speculation in housing/real estate isfeeding or ‘talking up' inflation in other sectors.
The inevitable increase in lending rates across the board may miss this particular target precisely because it isgeneralised; as interest rate costs move up uniformly, the impact on the speculative edge of housing prices may beblunted.
The RBI could introduce, as it did in 2006, risk weightages on real estate advances; that would be a form of selectivecredit controls RBI officials denounce as “a thing of the past”. But who would remove the distortions in the landmarket that ironically attract capital flows of the speculative kind? With its limited armoury, the RBI can do preciouslittle; with its fiscal and legislative powers, New Delhi has done even less.
