Column : Reserved bank

Written by Bibek Debroy | Updated: Apr 22 2009, 07:54am hrs
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It is current fashion to quote Keynes and he said, By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. It is no longer current fashion to quote Milton Friedman and he said, Inflation is the one form of taxation that can be imposed without legislation. At least on these two quotes, we have consensus across the two. Whats the inflation story, as per RBIs annual policy statement Point-to-point WPI-based inflation declined from a peak of 12.91% on August 2, 2008 to 0.18% on April 4, 2009. However, food price inflation is still high, which is why CPI-based inflation is still high. In February 2009, CPI (agricultural labourers) and CPI (rural labourers) show common inflation rate of 10.79% and CPI (industrial workers) of 9.63%, while in January 2009, CPI (urban non-manual employees) has 10.38%. Especially since April 2007, WPI trends have moved away from CPI trends, both when WPI shot up in April 2008 and when it has now declined. This has a lot to do with baskets and weights. But because of food inflation and CPI-based inflation, and because perceptions of inflation differ from actual figures, inflation remains an issue.

Fair enough. But does inflation have anything to do with monetary policy In terms of relative contribution to the fall in WPI inflation since August 2008, mineral oils and basic metals (combined weight 15.3% in WPI) together accounted for over 83% of the decline reflecting global trend in commodity prices. Thats as close to mea culpa as one is going to get. The decline in inflation was because of global factors. By the same token, high inflation was also because of global trends and tight monetary policy was unwarranted. This is for commodity prices. However, a similar logic also holds for food prices. The annual policy says the following and it makes you wonder. After clocking annual growth of 8.9% on an average over the last five years (2003-08), India was headed for a cyclical downturn in 2008-09. But the growth moderation has been much sharper because of the negative impact of the crisis. In fact, in the first two quarters of 2008-09, the growth slowdown was quite modest; the full impact of the crisis began to be felt post-Lehman in the third quarter, which recorded a sharp downturn in growth.

One can understand the post-Lehman statement. After all, the way we look at the world has now become BL and AL, standing respectively for Before Lehman and After Lehman. However, why was India headed for a cyclical downturn in 2008-09 and what happened in the first two quarters of 2008-09 What was this cycle There doesnt seem to have been any cycle in investments, at least not till then. Therefore, lets not duck the point that the first two quarters of 2008-09 suffered from monetary policy tightening. Whats the growth story Despite statements about export decline, corporate margins, IIP and dampened capital flows, there is a self-congratulatory under-current in what RBI says. Yes, 2008-09 will have 6.5 to 6.7% and not CSOs 7.1%. But 2009-10 will have 6%, there have been three fiscal stimulus packages, there is a NREGA, not to forget farm loan waiver and 6th Pay Commission. The combined fiscal deficit is 10.8% of GDP and we bid adieu (RBI and government would prefer au revoir) to FRBM. Investment declined in Q3 of 2008-09, but government consumption expenditure has more than compensated. Its because of these sentiments that RBI doesnt believe the growth story is dismal.

Had RBI believed the growth story to be dismal, repo and reverse repo rates would have been cut by more than 0.25%, perhaps 0.5%, if not 1%. One might even have tinkered with CRR. There is plenty of liquidity in the system, there has been monetary policy loosening already, there are time-lags. What more can we do There are systemic problems in transmission mechanisms. Small savings set a floor of 8% to deposit rates and this is a problem the government has to resolve. (There is also a transitory problem because banks are stuck with high-interest deposits that havent matured.) Cross-subsidies on below-PLR lending will have to come from somewhere and the new government (regardless of composition) will peg this at 4%, assuming party manifestos offer indications. Finally, government borrowing has wrought havoc and 2009-10 will be worse. So it shouldnt be surprising that the PLR range is between 11.50% and 16.75% in April 2009, compared to between 13.75% and 17.75% in October 2008. Its dropped a bit and there is still a scope for banks to reduce their lending rates. However, lending often takes place at higher than PLR and without systemic changes, no one believes PLR will decline by much, not unless SLR (statutory liquidity ratio) is changed from a minimum to a maximum. Thats a thought.

The author is a noted economist