Unfair to blame RBI for missing forecast, says Chetan Ahya

He said that a big inflation uptick seems to be improbable

CHETAN AHYA, chief economist and global head of economics at multinational financial services entity Morgan Stanley, answers questions from Anup Roy on the Reserve Bank’s (RBI’s) ongoing review of monetary policy and allied issues. Edited excerpts:

Your (RBI) policy expectation?

We expect the language to turn a bit more hawkish. Growth is improving, oil prices are going up and the central bank needs to indicate that the policy stance would incrementally move towards an eventual rate hike. We don’t expect them to hike rates in this meeting but the possibility increases from here.

RBI’s communication has come under criticism after the earlier policy statement and subsequently published minutes showed a mismatch. 

That happens in the case of the US Fed as well. At the time they are releasing the policy statement, it is the view of the whole committee, rather than one individual. Particularly in this last round of minutes, you had the deputy governor in charge of monetary policy as one individual who had a slightly different view from the other voting members. 

Is the MPC (the monetary policy committee at RBI) better than the earlier regime for deciding on monetary policy?

An institution taking the policy decision, instead of an individual, is definitely a better approach. The framework is a regime shift in India. As long as we know the framework, we can base our own assumptions and come up with our own forecast on the interest rate outlook. In the previous regime, it was a struggle to take a call on the basis of inflation. It wasn’t operated on a consistent framework. The latest framework will even encourage future governments to stick to a conservative fiscal path. 

Earlier, people were saying food inflation or commodity inflation was driving inflation and monetary policy cannot control those. That’s why they allowed high inflation to persist for five years and we eventually got to a negative real interest rate of 200 basis points. Inflation got ingrained, became vicious, you tried to protect growth by running negative real interest rates but, as a result, pushed up the current account deficit to 5-6 per cent (of gross domestic product) in the December 2012 quarter. In that period, (the ratio of) investment to GDP was declining and, yet, the current account deficit was widening because savings were dipping even faster.

RBI guidance (its forecast) changes frequently. Does it need to change its inflation forecasting model?

It is the situation with any forecasting institution. If your assumptions change, the forecast will change. This is something perhaps nobody can fix. The (US) Fed has been saying since the credit crisis that we will get to two per cent inflation. We got there only now. There are many variables such as oil prices, food prices, weather, etc, and it would be unfair if we think they will get the forecast right all the time.

In a country like India, where there are multiple variables, including breach of fiscal discipline, does a single mandate of inflation targeting make sense?

You have to go by the evidence. When we did not have that, were we better off? This will help enforce the discipline on the government because the government itself has given the mandate to RBI. The government knows that with this mandate, if inflation is running away, RBI will hike interest rates. It will make it difficult for the government to run a wider deficit.

Indeed, the government’s policies have so far not been pushing inflation higher. More, the government has not intervened in the labour market in the past four years. 

The government is heading towards an election. Are you worried?

I am concerned about the potential increase in redistribution-related spending. But, from what they have done so far, it doesn’t make us feel there is going to be a big inflation uptick. 

How risky is this rise of oil prices, and the oncoming elections for the fiscal deficit?

It is risky, but if it is demand-driven, you are probably going to see better exports and better capital inflows. In 2002 to 2007, when oil prices went from $30 to $90, India’s current account deficit remained in 1.5% range, inflation was also well behaved, there was some widening in fiscal deficit and that could have been avoided by passing through the prices. 

That was a mistake. This time there has been much more pass-through. The rise in oil prices over the last few quarters has been driven more by a pickup in global demand. Global industrial production and Y-o-Y oil prices are in sync. Gasoline, which is used by automobiles is a very stable component, but the industrial component, which is 50% of the demand is very closely linked to global industrial production. There is evidence that this rise in oil prices is led by demand and therefore, you will have a pickup in global demand, which is helping India. If you see the oil burden, which is oil volume of consumption, multiplied by prices and then divided by GDP. The oil burden for emerging markets, including India, is right now around 2003-2004 levels. It’s not significantly higher than the longer-term average of oil burden that the economy can bear.