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Column: Blind men in search of inflation

For the last few years, the Technical Advisory Committee (TAC) has provided advice to RBI on the setting of policy (repo) rates.

By: | Published: September 17, 2016 6:12 AM
Three of the six members of the MPC are to be chosen from outside of RBI. (Reuters)

Three of the six members of the MPC are to be chosen from outside of RBI. (Reuters)

For the last few years, the Technical Advisory Committee (TAC) has provided advice to RBI on the setting of policy (repo) rates. Very soon, perhaps as soon as the October 4 meeting of RBI, the Monetary Policy Committee (MPC) will be formed, and rather than an advisory role, it will make policy. In other words, rather than the Governor taking in inputs from the TAC, and others, he will now be part of a six-member committee deciding on policy rates.

Three of the six members of the MPC are to be chosen from outside of RBI. By definition, the five external members of the TAC are strong contenders for the three available slots in the MPC. But does the record of the TAC suggest that they are fit to take on MPC membership? Possibly not. (Important caveat—this is a summary conclusion; it might well be the case that some members of the TAC were not as thoughtless as the majority; the minutes of the TAC do not mention names.)

Monetary policy, without MPC or with MPC, is meant to be forward-looking, and anticipatory. Unfortunately, the record of the TAC, as gleaned from their latest, and last, August 9 recommendation, is anything but forward-looking. What has also been noteworthy about the TAC is that it most likely echoed what it thought were the “wishes” of RBI (traces of the elephant!). To be sure, individual members may have differed from the majority, but the majority has been nothing but His Master’s Voice (youngsters, look up what HMV was!).

Perusal of the TAC “recommendations” emphasises the fact that it has been broadly clueless about the determinants of inflation in India, and therefore not well informed about the determinants of policy rates. Their summary statement for the August 9 policy meeting is informative (TAC Report on the RBI website, August 30, para 3, page 1). For example, the TAC concluded that: “The monsoon has also been normal so far, although the targeted pulses production—pulses being a major driver of food inflation—will also likely be driven by higher minimum support prices in this sector.” (emphasis added).

The TAC contention that minimum support prices (MSP) for pulses will influence higher production is somewhat ill-informed. MSPs for pulses have been set approximately 8% higher for the 2016/17 agricultural season than the previous year —and at a level of around R55 per kg. The prevailing retail market price for pulses so far in 2016 has averaged almost four times this level (at R200/kg)!

However, a good monsoon this year is likely to send the retail price tumbling to close this huge “hoarders” gap between the farm-gate and retail price. What should be of concern to the TAC is retail (CPI) inflation for pulses—and this is likely to be significantly lower than last year i.e. pulse prices will help reduce inflation in 2016, contrary to the belief of TAC that MSPs for pulses will be inflationary. In other words, the TAC is looking at the “wrong” side of the elephant.

TAC again: “Members felt that increased upside risks to the 5 per cent CPI inflation target in Q4 of 2016-17 remain, specifically, from rising consumption demand—both private (because of a consumption led recovery) and public {one rank one pension; 7th CPC (Central Pay Commission)}—and cost-push shocks in the form of a steady rise in crude prices.”

This quote provides us some clue as to the thinking in the TAC. Worldwide, disinflation is the new phenomenon, and has been so for at least the last decade. Many economists (and policymakers) have realised that output gaps no longer explain inflation. If they did, then why did India have double-digit inflation in 2008-2013 with ever-slowing demand? So “rising consumption demand” will not be an important factor in future (or current) inflation. Just look at the lowest two years—accelerating GDP growth, and declining inflation rates.

What about the contention of the TAC that the Pay Commission will lead to higher inflation? In the last decade we had the Pay Commission, and observed high inflation; in the previous decade, we had the Pay Commission and obtained low inflation. So? It would have been more honest if the TAC had said that we don’t know much about the determinants of inflation, and are too lazy to find out—rather than arrive at wrong conclusions about inflation from models that do not make sense (if they ever did).

Undeterred, the TAC moves from one wrong conclusion to another. “Cost push shocks in the form of steady rise in crude prices”. One had hoped for a little bit of humility here—whoever the TAC might be, they are not oil-price experts. On August 8, 2016, the oil-price was around $44—a month later, it is exactly the same. More importantly, what evidence is there that a rise in crude prices leads to cost push inflation?

Perhaps the memory of TAC experts goes far back to October 1973, when a quadrupling of oil prices ushered in world-wide inflation. But their memory recall stops in 1980. In the 1990s, the average price of crude was $20/barrel. In 1998, the average price was a low $14.4. Since then, oil prices went up ten-fold, reaching a peak level of $140/barrel in June 2008.

What happened to world inflation post-1998? It continuously fell. The new near-40-year-old reality of crude oil and world inflation is that there is virtually no relationship. So, can the TAC oil experts stop looking for one?

The TAC noise continues. Sample this—four of the five TAC members were of the view that “CPI and CPI-food inflation have seen a recent uptick and certain other price indicators continue to be sticky; (ii) elevated food inflation has second round effects on headline inflation if it is persistently above double-digits”.

When was food inflation above double-digits last—how many months ago? In the last two years, the highest food inflation level was 8% (July 2016); the average (sustained) food price level has been nearly half the double-digit level (5.5%). So, can the TAC not confuse itself with second round effects if it can’t even observe the bare facts pertaining to the first round?

We all make mistakes—but so many mistakes in one expert TAC report is noteworthy and worrisome. It is to be hoped that when the MPC is constituted, and meets, the new members are unlikely to lazily assess, and forecast, inflation as the TAC seems to have done.

The author is contributing editor, The Financial Express, and senior

India analyst, The Observatory Group, a New-York-based macropolicy

advisory group. Twitter: @surjitbhalla

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