Taming inflation

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Taming high prices to get the economy in the shape defines Raghuram Rajan's agenda as banker to the nation, reports Manju AB

Taming inflation
Neither hawk nor dove. The Reserve Bank of India (RBI) prefers to be likened to the owl, for the monetary vigil it maintains like the night bird. A less charitable, but perhaps more apt description could be an insomniac, whose sleep has been robbed by the dogged inflation.

Inflation has been every Indian’s bedfellow for quite a while now. After the global financial crisis broke out like a rash, our government too did a quantitative easing of a different sort by flooding the market with cheap home and farm loans.

India did manage to stop the global contagion at its shores, but inside it began to bleed: easy money took its toll and inflation became a nightmare haunting everyone, RBI the most, for, at least in theory, it is the agency that’s supposed to make inflation disappear with whatever monetary tricks it can muster. It tried hard by repeatedly making money dearer — but failed. Inflation remained untamed and growth suffered.

Raghuram Rajan’s assumption of the RBI governor’s post four months ago raised a great deal of hope in industry that he would place growth over inflation. He didn’t. He prescribed the same medicine as his predecessor D Subbarao did — with some difference.

Rajan is firing from several barrels, hoping at least some of his initiatives would hit home. For starters, he has gradually shifted to inflation, targeting retail inflation especially, instead of juggling growth and inflation. He has also sought to get to the bottom of the bad loan problem at banks and revive stalled projects. To this end, he directed all banks to identify borrowers who have stalled projects and the reasons thereof.

In an interview with Financial Chronicle early last year, the then governor Subbarao had said inflation tolerance had come down. “We have given up the Hindu rate of growth and also the Hindu rate of inflation. We had a period of high growth with low inflation. An entire generation growing up in that era have low inflation tolerance,” he had said.

Since Rajan assumed office last October, RBI has hiked rates several times by a total of 75 basis points to 8 per cent. None of his actions had been predicted. And the rate hike earlier this week does not seem to be the last, though his guidance was that this could be the last increase if inflation cooled.

In which case, he added, real GDP growth could firm up from a little below 5 per cent in 2013-14 to a range of 5 to 6 per cent in 2014-15. To industry, that must have sounded like a dove’s cooing.

Arundhati Bhattacharya, chairperson of State Bank of India, said after Rajan made that pronouncement, “The guidance is the most important part of the (monetary) policy. It says there may not be any more rate hikes and this may be the last of the hikes, which is to say interest rates have peaked.”

That’s the cue most bankers have taken to postpone passing on the RBI rate increases to their borrowers. This defeats the purpose of the RBI rate hike, but Rajan can be trusted to tighten the screws when he finds out that banks are pushing back the goalpost.

Rajan told a TV channel on Thursday, “This notion somehow that RBI is standing in the path of growth is complete nonsense. It is extremely important that both the government and RBI are seen on the same page.”

“Many people are making the mistake of juxtaposing growth versus inflation but the simple point is unless inflation is brought down substantially, growth cannot happen and that is what we are tackling now. Once inflation goes down we will have the room to ease rates that can spur growth,” he said.

In other words what he is saying is that growth can be sacrificed in the medium term so that inflation comes down. The overheated economy needs to be cooled. At his first press conference as RBI governor in October, he had sounded more optimistic: “I think there are so many low-hanging fruits in the economy that if we only pluck them we can accelerate growth substantially.”

One cannot say for sure if it was to keep industry happy but the optimism is clearly trickling down. Banks are jointly picking the low hanging fruits. Rajan gave one instance: a company with Rs 30,000 crore plant was stuck in absence of permission to build a 20-km pipe. Banks and the company have worked together to secure the permission. The factory is soon resuming production. Rajan did not name the firm.

On the bad debt front too RBI under Rajan has been active. It is now easier for banks to sell their bad loans. Losses, if any, in the sale is to be absorbed gradually, but a profit goes directly to the bank’s profit and loss account. This encouraged public sector banks to sell at least Rs 3,000 crore worth of bad loans. Until a year ago, the amount of bad loans sold annually was barely Rs 500 crore. On its part, the government is playing ball with Rajan. Election or no election, they together must try and maintain any which way the fiscal deficit below 4.6 per cent of GDP and the current account deficit at the current level of 2.1 per cent. They seem to be succeeding — a good thing for the economy.

Among other steps, the government’s two committees — the cabinet committee on investment (CCI, created in January last year) and the project monitoring group (PMG, created last June) — to expedite big stalled projects have been of help. CCI has ended the logjam for 300 projects worth over

Rs 5,00,000 crore. PMG has accepted 411 projects worth Rs 19,00,000 crore for consideration, according to a document released by RBI. Both the government and RBI realise the need to right the wrongs.

But inflation remains the most important battle. A general belief is that genesis of inflation lies in the stimulus package India gave to itself after the global crisis in 2008. India was on a high as global financial crisis largely left it unscathed. But global economies today are interlinked: a contagion in one part of the world impacts markets across the globe.

To maintain growth by boosting domestic demand, the government gave what it thought was the best fiscal stimulus. The inflation risk in such a stimulus comes when demand is created but not assets.

The result has been unrelenting inflation. The consumer price index rose (retail inflation) by 9.8 per cent in December. Some of the pressure caused by vegetable prices is now off, but ‘some aspects of inflation’ are still sticky, according to Rajan.

“This suggests we probably need a little more medicine. We have injected some medicine — 75 basis points in rate hikes since September. We have to watch how the medicine works along with the weak economy and the rupee. Based on our projections, based on our models, we should be able to hit 8 per cent base on what we have done. But we have to wait and see,” Rajan said at a press conference.

Though still high, inflation as measured by the consumer price index (CPI) and the wholesale price index (WPI) declined significantly in December. But services were still costly. Also, non-food manufactured product price inflation rose; so did medical expenses and education. These and demand pressure worry RBI — the reason why another rate hike was thought necessary.

But it is not just food inflation that is costing India its growth. Price speculators abound here. So when coal blocks are auctioned, companies with no experience in the field win blocks and then sell them for a profit. The same story sullies the telecom sector too. Though Rajan and the government seem to work in tandem, some fissures have appeared lately. He has frowned upon the government’s financial jugglery and has come out openly against the increase in supply of subsidised LPG.

To contain the fiscal deficit at 4.8 per cent, the government wants a 10 per cent cut in plan expenditure. This would save Rs 55,500 crore. Despite the cut, expenditure growth in 2013-14 would be a high 14.2 per cent; in the previous year the growth was in single digit. The expenditure growth and cuts in capital allocation may prove inflationary, says a Emkay Global paper.

Dhananjay Sinha, institutional research head of Emkay Global, suspects the government would try to better its 4.8 per cent fiscal deficit target by the “usual year-end jugglery” at the cost of productive allocations.

India clocked an average annual growth of 9 per cent in the five- year period of 2003-08, raising expectations of a perennial high growth rate. Subbarao had once said, “For a nation that once believed that the Hindu rate of growth was its destiny, this remarkable growth performance was cause for celebration. It was also a trigger for setting off an aspiration for double digit growth.”

That was not to be. For that to happen, manufacturing growth must multiply, as in China. But we need to be grounded in reality here: we cannot become a manufacturing hub overnight.

Diwakar Gupta, former CFO of SBI says, “India has a problem of trade deficit. We are an agrarian economy having progressed to services economy without a strong manufacturing base. Our imports are inelastic… Exports cannot be pushed up at will and imports cannot be controlled. Invisibles will remain at a particular level — the Indian diaspora will hopefully continue to send home about $60-70 billion a year.”

In absence of a wide manufacturing base, our natural resources like coal and iron ore are exported. India is actually helping build the GDP of other countries. The poor manufacturing base comes out in other data. If one looks at sector shares of GDP and employment in 2009-10, the scenario is heavily skewed.

Agriculture contributes 15 per cent to GDP but employs 53 per cent of the population. On the other hand, industry contributes 20 per cent to GDP and employs only 12 per cent of the population. A little more balanced, the services sector contributes 65 per cent to GDP and employs 35 per cent of the population.

In a speech last year Subbarao has suggested a solution: absorbing some of the surplus agriculture labour in non-farm allied activities. The growing construction sector could also take in more labour. “But a major expansion of job opportunities in services is not possible without skill improvement. That takes time. So, much of the burden of job creation falls on the manufacturing sector,” he had said.

To understand the link of all this with inflation, one needs to look at the supplies of goods: shortfalls in farm produce in a deficient monsoon season or wastage create a scarcity, inevitably leading to high inflationary pressures. High cost of labour increases production cost and the prices of both commodity, and the final product. Supply driven factors are also a tool for regulation and moderation of prices. India has not used them wisely.

Ashutosh Khajuria, treasury president of Federal Bank, said, “When food prices rose earlier, Nafed intervened to bring it down. But now Nafed itself is a defaulter with many banks. It now deals with paintings. Inflation to a large extent is a supply side issue, but it has also got to do with speculators and bad policy management.”

Inflation or rather price management and egging GDP on cannot be RBI’s job alone. The government has a big role too. If it can cut non-planned expenditure and subsidies, it would have done at least a part of the job. If not, all the plans of Rajan and his men would fail.

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