As inflation remains high despite the Reserve Bank of India (RBI) hiking the interest rate several times, experts believe that the Union government’s managers do not have a complete understanding of the reasons behind the continued price rise. Also, there is no consensus on whether the RBI should pause its persistent monetary tightening stance.
The issue came up recently before senior officials from the finance ministry, Planning Commission, RBI, representatives of the International Monetary Fund (IMF), World Bank, Asian Development Bank and National Institute of Public Finance and Policy (NIPFP), besides economic experts from universities and research organisations.
At a meeting they held, NIPFB Director Govinda Rao and Chief Economic Advisor Kaushik Basu concurred the country’s economic managers have not been able to fully grasp the processes underlying the persistence of high inflation, according to an NIPFP release on Wednesday.
When contacted, Rao, who is also a member of the Prime Minister’s Economic Advisory Council, told Business Standard he said this to “provoke a discussion” on the issue.
He was of the opinion that the RBI should now take a pause on monetary tightening for a while and see how things pan out. “Monetary policy has a limited role in controlling inflation at this stage. As much as 35 per cent of inflation is still caused by food, which is feeding into general inflation and hence pushing the cost,” Rao said. In the meeting, according to the NIPFB release here, Basu put forward his now-famous idea that Turkey reduced interest rates when that country’s inflation was high — and succeeded in both taming price pressures and boosting growth.
The time has again come for the RBI to chart an out-of-the-box solution to contain inflation, he added. However, Rao said, “I don’t support the RBI’s rate cut. Turkey did it because of huge capital inflows by FIIs (foreign institutional investors.” Even after 12 policy rate hikes by the RBI, repo rate still remained at 8.25 per cent, lower than pre-crisis level, Rao noted.
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Wholesale price-based inflation rose to a13-month high of 9.78 per cent in August from 9.22 per cent in the previous month. The figures were released just two days before the RBI hiked policy rates for the 12th time.
The IMF also said real policy rates are still low in India. However, in its World Economic Outlook released yesterday, the IMF made this observation to put forth the point that the RBI should further hike the policy rates.
At yesterday’s meeting as well, the IMF representatives called for an even more hawkish stance by the RBI. They said high inflation persisted because the ‘baby steps’ of small increases in policy rates that the RBI implemented had been ineffective in anchoring inflationary expectations.
The group claimed there was “enough information” which indicated that a wage-price spiral fuelled by inflationary expectations was driving inflation. According to this line of argument, the RBI should have adopted a shock treatment policy of very sharp interest rate increases to kill inflationary expectations at the outset of its current monetary tightening policy stance.
Critics of this view pointed out that while such a shock treatment might indeed have killed inflation, it would have also simultaneously muzzled growth and triggered a problem of insolvency among debtors.
In this context, it was pointed out that such shock treatment in the early 1980s by America’s Federal Reserve had successfully curbed inflation in the United States, but it nevertheless generated the Latin American debt crisis.
Economist Mihir Rakshit put forward an alternative point of view, and said the recent spell of inflation in India had been of the cost-push variety, arising in particular sectors, and not attributable to generalised excess demand. Rakshit, along with Planning Commission member Abhijit Sen, pointed out that cost push inflation is being driven by high global commodity prices, including oil, metals and food.
In other words, India is experiencing imported inflation. It cannot be easily tackled through aggregate demand compression policies such as interest rate increases.