There are several benefits to the ongoing commodity inflation crisis. The crisis will separate the genuine leaders from mere followers across the world. It will separate the real experts from the wannabe also-rans. Since we don't know the future, all of us forecasters are subject to the test of future reality. As the forecasts are made, all us spectators can do is to look for internal consistency in the arguments. This is where ideology meets empirical evidence "" a rock and a hard place, but... |
The raging debate around the world is centred on inflation. Sub-prime and slow growth is passe; inflation, "anchoring of inflation expectations", and targeting inflation is the new policy concern. This is the case around the world "" from the US to India, from China to South Africa. As we circle the globe, let us examine the separate, but often blurred, roles of ideology and policy.
If it is inflation, the European Central Bank (sometimes affectionately known as Extremely Confused Bankers) should be the first stop. The ECB cast is known to believe that inflation everywhere and every time is a monetary phenomenon. So their response is to tighten money and credit to slow down inflationary expectations. This is what they have been doing for the last several years.
One of the strong links in this anti-inflation policy has been the appreciation of the euro. Just recently, some more hawkish than a hawk members of the ECB have said that maybe interest rates should be further raised in order to "anchor inflationary expectations". But just yesterday, ECB Chief Mr Trichet, responding to a decline in investor confidence in Europe, suggested that a major part of the problem for European growth was the low value of the dollar. I guess he was too embarrassed to state the obvious "" that the weakness in the dollar is mirrored one-for-one in the strength of the euro; and that interest rate inflation-fighting hikes would further strengthen the euro, and further weaken the European economy. But maybe the strength of the euro does (did) manage to lower inflation? That empirical evidence goes against the ECB "" the euro has appreciated by a large amount (25 per cent), and inflation in Europe has accelerated (almost doubled) by 1.5 percentage points (ppt) "" from 1.8% per annum to 3.3% p.a. The dollar has depreciated, and inflation has mildly accelerated by 0.4 ppt to the same final level "" 3.4% pa.
Concern about global inflation prompted the Indian government to launch an investigation into the role futures markets play in generating inflation in food prices. Yes, you heard it right; it was only yesterday that the very same Indian government had set up an agricultural futures market to help farmers in the process of price discovery. Futures markets mean lower and more efficient prices for all, i.e. lower inflation. But consistency has never been an attribute of the ideologues. But the case gets stranger still. It is reported that only one member of the committee, its chairman, Dr Abhijit Sen, recommended the ban on futures trading to continue; the rest of the Committee believed that the ban should be revoked. Now government committees are not always a con job but most often contain elements, i.e. at least some members are rigged to blindly parrot the views of the chairperson. Hence, with complete disagreement with him by his own team, Dr Sen has achieved an impossible but admirable feat. Ideology can take one to strange heights.
So far, inflation-fighting policy in India has been OK "" cutting taxes, excise duties, etc. But there are two worrisome signs. First, the threat by the government to consider steel an essential commodity, i.e. something the babus and their mentors can play around with "" in the name of ideology (fighting inflation)! If it does happen, then the PM, Dr Manmohan Singh, will have seriously begun the process of destroying his legacy as an economic reformer. By believing that cartels (in this day and age of imports of everything from cement to pipelines to Chinese workers) can operate in today's world in cement and steel, the finance minister, Mr P Chidambaram, has lost considerable credibility as an economic reformer. However, I still believe in the Doctor and PC. It is very likely that what the government is practising (albeit in a ham-handed manner) is jawboning, i.e. applying pressure on the firms to cool it, in the inflation sphere, for a few months. Inflation will come down, and then we will all be normal again.
The second area of concern is the soon to be announced monetary policy (April 29). The RBI has already raised the cash reserve ratio by 50 basis points. This is equivalent to the FM talking about cartels. But if the RBI were to raise repo rates, then that will be equivalent to declaring steel an essential item "" ideological madness. For those goading the RBI to tighten policy, answer these questions. Relative to 2006, India has been one of the worst growth performers in 2007. Tight monetary policy (non-food credit growth has decelerated from 30 plus per cent to only 20 odd per cent) has ensured an across-the-board decline in growth. At the peak year-on-year growth in credit (last several years), inflation was at its trough; at the slowest growth of credit in several years, inflation is at its peak. What better proof is needed about the damage that ideology can do? In addition, India had a 10 per cent appreciation of its currency to fight inflation. The "credit" for this ideology most likely goes to the Ministry of Finance, which believes (believed?) that exchange rate appreciation not only reduces inflation but does so massively, i.e. each 10 per cent rise in the value of the currency leads to a 2 per cent decline in the rate of inflation. Snake oil salesman have better evidence; but then, they don't have a blinding ideology.
The author is Chairman, Oxus Investments, a New Delhi-based asset management company. The views expressed are personal.