Column: RBI: wake up, smell the coffee

Written by Surjit S Bhalla | Updated: Mar 16 2013, 06:38am hrs
These are the facts of the Indian economy that RBI is confronted with for its meeting on March 19 for the future course of monetary policy. Economic growth the lowest in the last decade, and among the lowest in the last three decades. Consumer price inflation, especially food inflation, the highest in over two decades. After the 1991 reforms, consumer price inflation has averaged 7% per annum. The last five year averageabove 11%, with peak inflation above 15% in 2009 and the lowest being just shy of 9% in 2010. This is not the occasion, either for us or RBI, to go into the causes for this inflation. The determinants are more than well knownreckless welfare expenditures that bear the blunt signature of the leader of the Congress party, Ms Sonia Gandhi.

There will be many occasions to go into the fault-lines of Sonianomics, though it is unclear whether the moniker should have any association with the word economics. But that discussion is better left for the near future. At present, it is critical that RBI make the correct decision on March 19. In my opinion, and what the facts documented below suggest, RBI should cut rates by 50 basis points, with the promise of much more if Sonias government begins to behave responsibly on the major generator of food and CPI inflation, the procurement price of food grains and, in particular, rice, whose policy announcement is expected next month.

Several data relating to growth and inflation are presented below. My apologies, but I want to leave no data unmined. RBI has proved itself to be more than adept at changing goalposts, and surprisingly, still scoring several self-goals. Among all the economic data available, there is one indicator that says RBI should not cut ratesit is the elevated 10%-plus level of food inflation (food has an approximate 50% weight in the CPI and is proxied by it in the discussion below). But the should comes with a caveatthat RBI believes that monetary policy, in the form of overnight interest rates, can affect food inflation. If it does believe that, then RBI should offer at least minimal evidence to support its claim. It should explain how CPI inflation decreased from a 13.7% level in April-June 2009, when the repo rate was at a low 4.75%, to a 10.6% level when the repo rate hit its peak 8.5% rate in October 2011. CPI inflation remains close to its 10% plus level today, and the repo rate is lower by 75 basis points at 7.75%.

The data suggests that when the repo rate is increased, CPI inflation increases, and vice-versa. Okay, I exaggerate a littlethe fact remains that there is a zilch relationship between the food-dominated CPI inflation and the repo rate.

If that is the reality, and it is, and RBI still persists in citing food inflation as a cause for it not cutting rates, then it would be yet another illogical chink in RBIs armour. And to be consistently inconsistent, it should raise repo rates in its fight against food inflation. And RBI should offer at least an obfuscation as to why its concerted hiking of interest rates has resulted in a zero impact on CPI inflation, and why it expects this time to be different.

Food inflation is essentially a supply-side phenomenon, and especially in a country like India where food prices are in the nature of administered prices and where production, exports and imports are heavily controlled. In such an environment, to expect interest rate policy to have any effect is to expect the impossible. But everyone is entitled to their opinions.

However, as far as proof about the efficacy of interest rate policy on growth and inflation is concerned, there is a tonne of evidence. Some of it is presented in the table. All the data are seasonally adjusted annualised quarterly rates (SAAR). The data are presented for the September-December quarter in each of the last three years; plus, when available, data for January-February 2013.

First, growth. A total of five indicators are shown and all of them show a disastrous collapse. Industrial production growth starts of at a healthy 8.4% and ends at 3.2%. GDP manufacturing starts at 12.2% and ends at 7.8%. Even services growth is not spareda decline from 8.4% to 5.9%. And GDP at factor costfrom 7.6% SAAR in the fourth calendar quarter 2010 to 5.2% in the quarter just ended.

The inflation numbers are truly horrific. First, horrific on the high side. Come rain or shine, or hike or lowering of repo rates, Sonianomics has ensured that food inflation stays rampant, and hurts the poor (Congress leaders, ever wondered why you are losing every electionand losing bigsince populism inspired food inflation raised its ugly head). CPI inflation15.8% in 2010 and 10.9% most recently. WPI15.4% in 2010 and 5.1% today. Agricultural GDP deflator21.2% in 2010 and 6.3% in 2012. Non-agriculture deflator7.0% to 6.2%. Manufacturing a decline from 7.5% to 4.8%. Servicesdecline from 8.5% to 6.2%. WPI manufacturing8.8% in 2010 to 0.1% for the first two months of 2013. Core inflation as defined by RBI9.2% in 2010 and 0.9% today. Remember, all the inflation rates (as well as growth) have been annualised. Some misguided inflation hawks might read these numbers as month on month inflation rates. No, they are annualised, i.e. core inflation is registering a less than 1% annual rate.

The non-food economy is as near to a stand-still as we can get. If these numbers do not motivate RBI to move aggressively to shore up the economy, and jobs, and the poor savers RBI speaks so passionately about (the poor savers are those who are rich enough to save but are only obtaining 9% interest rates on their deposits), nothing will. As quoted in the Hindu Business Line (August 16, 2012, RBI stance has succeeded to some extent, says Subbarao), Powerful and resourceful corporates may protest high interest rates, but there also exists a vast majority of silent poor who suffer worst from high inflation. Unlike in the formers case, their voice is not heard in the media. Also, savers want high interest rates while borrowers would not like to contract money at those rates. It is a time-honoured relationship that savings arise from incomeno income, not only no savings, but dissavings. If Subbarao wants savings rates to go up, he needs to start cutting interest rates aggressivelynow.

Surjit S Bhalla is chairman of Oxus Investments, an emerging market advisory firm, and a senior advisor to Blufin, a leading financial information company. He can be followed on Twitter, @surjitbhalla