A V Rajwade: Winners and losers in the inflation game

WORLD MONEY

Now that inflation is below the magic 5 per cent number for the third week in succession (and, perhaps more importantly, the ruling party has done better in the recent election in Goa after a series of electoral defeats), is it time for the RBI to declare victory and change its policy stance? Some commentators have described the development as an "important victory over inflation". But, in the real economy, who are the winners and the losers of the steps taken by the central bank?

The man on the street does not believe the inflation numbers in any case, and the poor who are supposed to be the most affected by inflation (are they not affected even more by unemployment?), are unlikely to feel the difference between WPI rise of 6.69 per cent (January) and 4.28 per cent now. The principal reasons for the fall in the headline number seem to be two: the base effect, which has nothing to do with the existing monetary policy, and the fall of the rate of rise in primary goods. Neither can logically be attributed to the tightening of monetary policy during the last eight months.

Direct impact apart, the short-term objective of monetary policy is to change "expectations". One major macroeconomic variable in respect of which expectations have dramatically changed is the exchange rate policy of the central bank. Having allowed the rupee to appreciate by as much as 15 per cent in less than a year, the real economy knows that the rules of the game have changed dramatically. One manifestation is that TCS, the largest IT company in India, has decided to increase 5,000 jobs in Mexico, in preference to India, because of the more favourable exchange rate regime. It is also increasing jobs in the rest of Latin America. A recent study by the Confederation of Indian Textile Industry (CITI) estimates that the steep appreciation of the rupee would lead to the loss of around 6 lakh potential new jobs in the current fiscal year alone. Already, employment gains from textile exports have been reduced by almost 60,000 in 2006-07 itself. If we risk missing the growth in textile exports even after quotas have been lifted, diamond and other labour-intensive industries will increasingly find the attractions of transferring, or at least diversifying, business to other locations, stronger.

The small and medium enterprises (SMEs), which were already finding it difficult to face competition from Chinese imports in sectors such as chemicals, textiles, consumer goods, electronic gadgets and toys, electricals and so on are finding their competitive position in the domestic market much worsened; SMEs have seen their interest cost go up by 3 per cent plus, even as the exchange rate has appreciated very steeply and significantly. Even large industry is hardly immune: vehicle manufacturers are switching to imported tyres in preference to domestic ones; the former are already a large segment of the replacement market. The deflationary monetary policy will surely tell on the quality of bank assets.

The middle class has also been hurt by the higher cost of home and consumer loans. The vehicle and auto ancillary sectors have been hit by slowing demand. The lower demand for houses in turn affects creation of jobs in the construction industry which, according to a study by CII, is one of the largest creators of jobs for the unskilled""and this at a time when the economy cries out for creation of jobs for the relatively unskilled. (But the effect on employment should be no surprise "" as Keynes argued a long time back, "there is no other way by which bank rate brings down prices except through the increase of unemployment".) Has the pain inflicted served any useful purpose?

But coming back to the exchange rate, in the whole media debate, much commentary is focused on continued export growth""with little attention to import growth or the deficit in merchandise trade. The deficit has jumped to more than $7 billion, that is, by 80 per cent, in the month of April. The commerce ministry seems to be clutching at straws like hike in duty drawback, cut in interest rate on export credit, payment of interest on EEFC, and so on. Even if its wish list is fulfilled, this would do little to improve the competitive position in the absence of a far more reasonable exchange rate.

To be sure, there are some major gainers from the policy "" FIIs, large companies which have raised ECBs, buyers of luxury imported goods, and so on. Who else?

Tailpiece: In a speech in Mumbai the previous week, the Finance Minister expressed disappointment that "the total assets of the Indian banking system" are less than those of ICBC, the second largest Chinese bank, alone. But the central bank has been distinctly uneasy with the growth of assets of the industry and has successfully brought down the rate of growth! How can we ever make up the yawning gap in size?

avrajwade@gmail.com