Wednesday, June 6, 2012

Check Inflation in Indian Economy or Perish: A preview of June18,2012 RBI credit policy review.

After the fiasco with wrong data relating to sugarcane production released by the CSO, statistical arm of the  government and subsequent downward revision of the agricultural production in the month of March comes a shocker in May. The 4th quarter GDP growth figure is a paltry 5.3% which brings the 2011-12 GDP growth figure to 6.1% instead of the 6.9% projected just two months ago by the finance minister in his budget speech. Almost as a spontaneous reaction, the chambers of commerce have been clamouring for more rate cuts to stimulate growth. Although RBI had cut rates in the month of April by 0.5% to 8% after a long period of  status-quo; (presumably to help government borrow money for its planned expenditure;) it had done so only on the cushion of better figures of inflation. However it had cautioned that it will monitor the inflation rate and expected the government to spruce up its deficit management skills both in fiscal account as well as current account. The inflation figures released in May point to a moderate increase in WPI to 7.23% while food inflation has touched 10.5% out of which vegetable prices have risen by 28%. To make matters difficult for the government, the rupee has slid to the lowest figure against the dollar at Rs.55-Rs. 56, spiralling the current account deficit .

RBI has a credit-policy review on June 18th. Will it cut lending rates further to stimulate growth as their Deputy Governor seems to indicate ? But that would mean going back on its  own statement made in April when it said that it will have to wait for inflation rates to be down substantially for any more monetary easing. Apparently since the crude oil prices are down, thanks to a shrinkage in demand of the  construction sector in China , it gives RBI the necssary leeway.

There are two fallacies in the argument here. Firstly crude oil prices go through a lag effect before affecting the general inflation figure and the volatile exchange rate can negate any positives. Secondly , credit stimulus can only stimulate growth if the problem is in the supply side as most industry bodies seem to claim . But the problem is clearly in the demand side now as is evidenced by falling automobile sales figures, a mere 3.4% -the lowest April growth figures. There is a demand shrinkage happening because of high figures of inflation both in consumer perishables and durables. Creating more supply infrastructure with the additional credit is only going to let goods get stocked in warehouses unless of course the additional credit is used by crony industrialists to either siphon off the money or lock it in properties without creating additional supply units. Clearly the growth figures in India since the 2008 financial crisis have been pretty good hovering around 8% throughout . But what the figures have masked is that the inflation figures too have been pretty high and around the same level of 7-8% ; implying thereby that the growth story for last 4 years have actually been more inflationary growth than any growth in real demand.So long as the demand didn't shrink, the story was fine. But since indications are that there is a shrinkage in demand , RBI should wait for the general price level to fall down further allowing demand to pick up before effecting any lending rate cuts because persistent high inflation can not only cause economic problems but it can also generate social tensions and cause the government more political problems than it has anticipated.


Salty said...

The Prime Minister yesterday announcd a glut of measures to develop infrastructure that included two ports, thousands of miles of highways, roads, bridges,18000 MW of powerplants etc. etc. According to him, such measures will create growth in the country and will bring back out GDP grwoth rate to 9%.
The point is about the timing of such measures. Firstly , immediately after the financial crisis, the government announced huge spend after infrastructure but investments whether from India or abroad were not forthcoming as the finacial crisis had dried up credit globally. And now with India's growth rate faltering, the government is talking of austerity measures as it doesn't have enough finances to fund its own activities while foreign investment in infrastructure will definitely not be forthcoming when hurdles over land acquistions,power tariff,energy tariff are yet to be resolved and who is going to put in money where not only the cost of capital is high but also the berak even period is invisible. Finally the PPP model of partnership haven't really set the trail blazing so far.
In summary,the UPA government riddled with accusations of misgovernance & corruption and charged with driving inflationary growth for the last 4 years ; is simply resorting to promises which will be re-mouthed over the next 2 years till elections are due and with no obligations to fulfill the same.
The PM has now become more of a distinguished politican or an "extinguished economist", as he himself light-heartedly mentioned some time ago.

Salty said...

The IIP (Index for Inudstrial Production) growth data for May'12 released this week is a paltry 0.1%. While consumer goods showed a marginal increase , capital goods are hovering at a negative growth figure.The inflation data released yesterday by a politically busy Finance Minister shows further increase (though, marginal) to 7.5%, while inflation of food prices is still at double digits and vegetable prices have shot through the roof with a figure of 68%. With gradual erosion of purchassing power as well as of savings thanx to persistently high foood inflation , its simply becoming difficult for an average Bengali to have his daily meal of rice with vegetables,pulses & fish curry. Mutton prices are equal or cheaper to some of the small fishes in the market.
Predictions about onset of monsoon 2 months back sounded exactly same as that of the finance minister's predictions on slowing of inflation in his budget speech or the IIP data fiasco earlier. Covering more than revealing, they were/are political statements to protect the image of the ruling party.
The monsoon is already delayed by two weeks and further delay or scarcity will have a disatrous effect in the rural food-growing hinterlands of India. Another potentially inflationary cause is just building up. The RBI should not only wait for good news on inflation and monsoon for atleast two successive months before any decision on rate cut can be taken.What the government can do is to release the red tapes on various infrastructure projects that are in the pipeline. It'll take at least a quarter to kick those off.
With no increase in real income, inflation is slowly eatting into the purchasing power of the people and causing a shrinkage in the demand. The consumer goods IIP data might not bring any cheers next month.
The government is now of course busy in preventing its premature downfall as they plan to hoist the politically suave finance minister to the ceremonial post of President. In case of any no-confidence crisis in the near future, the President will have the prerogative to call the leader of the largest party and new formation of government. The opposition & "neglected-allies" are unlikely to refuse this political challenge and all kinds of backroom political activities have taken centerstage leaving the ailing economy to take care of itself. To quote a popular Indian phrase, its now "ram bharose" (in god's hands). So much for democracy and good governance!!!