As I write this post, the Indian stock market continues bleeding over the steps taken by RBI yesterday to curb inflation, as they say. This RBI action and policy seems highly irrelevant to me, keeping in mind the nature of inflation at this point of time in India. The inflation is predominantly due to Supply side factors and is highly dependent on external factors. The RBI intent to reduce the demand is really not going to give substantial relief to the Government.
When I write this, I believe RBI Governors to be this cognizant of the situation and well averse in economics. Then why did this policy? The only reason I come out with is their hidden intent of reducing fiscal deficit through decrease in demand, primarily with imports. India is reeling through high amounts of fiscal deficit and it is going to shoot up seeing that there is no one time windfall gain like last year(It was 6.5% excluding the cash inflows of 3G auctions). The high debt levels of 78% makes Indian economy susceptible to economic shocks. Also, north bound oil prices are creating pressure on the Government to reduce the demand as a $10 rise in crude prices led to 0.3% increase in fiscal deficit of India.
Thus, this monetary policy of RBI is more governed by the Finance Ministry over reducing the nation's deficit. But the flip side is that it can lead to permanent/long term 'Crowding Out' of Private investments. The Growth rate estimates have declined to below 8% and could ruin the honeymoon period of the companies. But the valid question is whether double digit growth sustainable in an economy that is democratic, with limited/less natural resources (primarily energy) and an immature manufacturing sector? Moreover, Indian economy is highly dependent on the big developed countries for its revenues from service sector and it also does not peg its currency as China does to boost the exports. Keeping in mind these constraints, it is really a very difficult challenge for RBI to grow the economy by double digit while maintaining, if not reduce, the fiscal deficit at current levels.
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Nice Article. However, I am not sure whether covertly managing the fiscal deficit was the motive behind RBI's act. Ofcourse, running high FD crowds out private investment as interest rates rise due to the GOVT's demand of the money.
ReplyDeleteMr. Subbarao has clearly mentioned that inflation is the target. The inflation has been above 8% during this time.RBI's target is to bring this down to 6%. Also, the growth is on more solid track now.
The events in the islamic countries has kept alive the concerns regarding crude prices which is the biggest import item and cause for non food inflation. The commodity prices have also been quite volatile recently.
We should also not forget that containing prices is the topmost concern in the mind of the governments (especially during the time the election). The elections are underway in 3 of India's states and hence, the attack on inflation.
I agree that unless private investment occurs substantially (especially in infrastructure), it is difficult for the government to finance the asset creation by running high FD. Well, all those theft in the name of the subsidies and various scams which are nothing but the non value creating expenses make a huge dent in fiscal deficit.
Again, a nice article. Keep it up.
Chaitanya
Great start. Serious writing. Let me put it very simply. There was no other way than a 50bps tightening. And many economists believe that RBI was lagging behind the cycle in rate tightening especially worried over fragile nature of global recovery.
ReplyDeleteThe first and foremost point whatever the case may be a ~9% of headline inflation rate is not desirable. And low rate and high inflation can't be the case due to simple policy mismatch.
The inflation has shown a great shift in the last couple of months and just being driven by food and crude it has shifted to a broader demand inflation as observed by core inflation rate. In such scenario you don't have a choice but to increase rates.
With unsustainable high level of oil marketing companies losses there is no other way than increasing petrol/diesel prices. And that would further fuel to this fire of inflation.
So as central banker you can watch your economy overheating just for the sake of injecting false optimism in the stock market. And as a regulator you can't act to remove supply side constraints. You have to do your job for the welfare of the economy. And well said by Subir Gokarna that inflation is our top priority at this point of time and we have to curb it even at the cost of growth!
@ CG & Avinash..
ReplyDeleteThanks. And precisely my point was that 50 bps rise will not help in reducing inflation substantially. The fact that predominantly it is due to Supply side factors. Also, RBI does not work alone; it should have raised the rates in consultation with the FM.
one must consider a number of factors that both the RBI and the FM must have looked at before the hike...
ReplyDeletethe oil prices in the middle east are not expected to fall in the next few months. the fact that osama was killed will surely incense the al-qaeda in Iraq and also there is bound to be an internal pressure developments on countries like saudi to reduce the US influence in the region and to teach them a lesson!! OIL will shoot up in no-time. as long as the prices dont stabilze around USD 100.. there will be issues that the govt will have to address through regular fuel price hikes. expect the next one in the next 1-2 weeks to push the inflation further.
the problems with food procurement this yr in punjab and haryana mean that food inflation will reach newer levels in the next 2-3 months. while sharad pawar may not do too much, the RBI and the FM will be under pressure to do all they can to reduce headline inflation.
consider the case with realty prices in cities like mumbai and delhi. inspite of an inventory of 90000 units in mumbai, the prices refuse to fall. this is another indicator that there is a lot of loose money floating around the market.
if inspite of the high inflation and the FD, we are to grow at levels of 8-8.5% in fy11-12, we do need tremendous support from large foreign investors who are willing to invest in infrastructure and that to on a massive scale. recently i read somewhere that to meet our infra needs in the next 25 years we need an investment in the order of 500b usd!!!
We must expect a revision in the growth targets in the coming months.. by the WB and by goi for our economy. infact we must all be prepared for another rate hike of 50-75 bps in the next quarter.
it was almost a year ago that montek and gokaran had both promised to get inflation to decent levels (5-6% odd)by december last yr... for that to happen inspite of all the xternal factors.. medium term growth has to be scrificed
and btw nice post kp sir!!! i hear they called you the finance guru at 'C'. No wonder!!!
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