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RBI governor Raghuram Rajan has said no single data point will determine the RBI’s next move on interest rates, although with CPI over 10% and WPI at the 7% mark, economists seem to believe that the central bank will continue with its hawkish stance in the December credit policy. The government of course, has continued to maintain that disinflationary forces will start kicking in and prices should come down in the next few months, easing the RBI’s policy fix.
In an Op-Ed in The Hindu, IGIDR Professor of Economics Ashima Goyal concurs with this position, saying ‘hopeful signals’ are emerging on the many nominal variables that have persistently contributed to high inflation in the past couple of years.
Here are the 5 ‘hopeful trends’ according to Goyal, which point towards an easing off in prices:
1) Reversal in INR depreciation, CAD reined in
GOYAL - “To start with, we seem to be settling to some exchange rate stability around the ‘equilibrium’ real effective exchange rate. This reversal of excessive nominal depreciation that would have contributed to inflation, along with a clear reduction in the current account deficit, may help the economy to cope better with what is likely to be a gentler-than-feared US Fed taper.”
The rupee is 10% off its lows and this appreciation is a good thing because a lower rupee would have fed into higher inflation. Some estimates suggest depreciation by 10% adds 0.8 percentage points to inflation. When the currency depreciates, we need to pay more for imports, which puts pressure on inflation as the costs are passed on to consumers. With the INR stabilizing, the cost of imports will come down.
Curbing the current account deficit through import restrictions also eases inflationary pressures as it compresses aggregate demand. India is expected to contain its CAD at $55 billion, much below the earlier anticipated 3.8% or $70 billion number.
2) Fiscal redline unlikely to be breached
GOYAL - “Despite this being an election year, the government seems quite committed to meeting its fiscal deficit targets and like last year may cut fourth-quarter spending.”
A bloated fiscal deficit leads to higher government borrowing, crowding out private sector availability of capital, leading to an increase in interest rates which eventually causes inflation to go up. It also leads to greater supply of money, boosts aggregate demand, which without a concurrent increase in supply of goods as in the case of India, fuels inflation. There have been concerns that the government will breach its 4.8% deficit deadline but finance minister Chidambaram has been adamant that the number will be curtailed at below this level by cutting non plan expenditure. This is inflation positive.
3) MSP increases moderate
GOYAL – “Third, we have seen only moderate increases in minimum support prices — again despite this being an election year.”
MSP is the rate at which the government procures grains from farmers. A consistent increase in minimum support prices is seen to be one of the structural factors behind food inflation. A 10% hike in MSPs raises short-term wholesale inflation by one percentage point, according to a Hindustan Times report quoting an RBI study. The report also states MSPs have risen by an average of 15% over the past 6 years. This year though, the government has increased prices only by 5% for crops like paddy and wheat, which in turn will have a moderating impact on food inflation.
4) Rural wage growth falling
GOYAL – “Rural nominal wage growth is down from 20 to 15 per cent, while in real terms, wages in August were up only 2 per cent year-on-year. Wages in the last few years were overcorrecting to steep food price increases, which again had major second-round effects on inflation.”
Rural riches as a result of the rural-employment guarantee scheme, and inflation indexed rural wages are frequently cited as the key contributors to high inflation as they supported rising rural demand and also increased cost of production, feeding into inflation. But a moderation in real wages is expected to bring demand down, reining in inflationary pressures. "Though rural wages continue to rise, the pace of growth is moderating. Growth in the average daily wage rate for agricultural labor dipped to 13.1 per cent in August year- on-year, which is significantly slower than 18.5 per cent in 2012 and 23.4 per cent in 2011," Nomura said in a research note recently.
5) Good monsoons, bumper Kharif crop
GOYAL – “Good monsoon and some softening of global food prices, can help bring about stability in real wages over the longer term.”
The government expects a bumper Kharif crop and the finance minister has been quoted as saying output will be 10.3% higher than advance estimates. Production is estimated at 129 million tonnes vs. 117.8 tonnes in 2013 and economists are hopeful that prices will come down on the back of this bounty. "The weak state of the economy, as well as the good Kharif and Rabi harvest on the back of a good monsoon, will generate disinflationary forces that will help, and we await data to see how these forces are playing out.” The RBI governor said recently.
Meanwhile good monsoons have filled up reservoirs which mean lower irrigation costs and fuel costs, higher planting and a jump in output which could depress prices.
But…
Goyal believes these are only short term positives. And in the longer run the government really “has no long-term strategy on tackling food inflation. Reducing excess policy focus on food grains and eliminating distortions in agricultural marketing are required to encourage crop diversification and meet changing consumer demand. Sectoral interaction and linkages cannot be ignored in India. As food inflation raises wages and forces monetary tightening, industry is squeezed from both sides.”
These structural problems have been spoken of ad nauseam, and if indeed there is likely to be inflation respite in the medium term, the government must take the opportunity to act on them But higher rates is not the solution feels Goyal. “A neutral policy rate should be enough to anchor inflation expectations. The current repo rate appears to be close to it” she says.
