Welfare programmes alone can?t explain the higher consumer demand. Large rural land sales possibly can
This is not a paean to cutting rates. It can?t be. Which central bank can legitimately wade into (further) monetary policy easing when the maximum function of the multiple inflation indicators that are tracked by RBI is reading 11%?
Instead, this is in partial response to some issues raised in two very thoughtful, reasoned and readable speeches of the RBI Governor in the past few days. This is an attempt to understand and partially indicate the causes of one of his queries: why has inflation remained so stubbornly high when all growth indicators are flashing red. Particularly when some of the best economic minds in India are beginning to speak of ?stagflationary tendencies??
Retail inflation has remained high since at least the introduction of the new Consumer Price Index (CPI, supposed to better represent the consumption basket) in 2011. Month after month, CPI inflation has remained upwards of 8% for the past year. This is not just a rural phenomenon; if anything, urban inflationary pressures are even higher. However, given the channels of interaction between rural and urban India?food, labour, among others?rural inflation can be easily transmitted to urban areas.
The usual suspects, the ?idiosyncratic factors? mentioned in Governor?s speech??supply bottlenecks, particularly in infrastructure, sectoral imbalances, rise in wages without a corresponding increase in productivity, higher fiscal deficit and ? depreciation of the exchange rate??are certainly factors, but are relatively incomplete as explanations. Why, for instance, are wages rising when growth has steadily faltered? Is it because there is a serious skill shortage which compels employers to pay more to retain talent, even when business growth might be faltering? Some explanations are simple: the prices of eggs and poultry, a significant portion of which are sourced from Andhra Pradesh and Tamil Nadu, are due to lack of electricity, which compel hatcheries to produce at levels far below potential. But there has to be more than this.
First, it is evident that rural wages have significantly outpaced productivity increases (chart 1). There is also little doubt that there is a cause-and-effect linkage between inflation (particularly rural) and wages (chart 2). Barring occasional divergences caused inter alia by weather abnormalities, the co-movements are quite striking. But this, in turn, begs the question: why have rural wages been increasing?
One of the usually-cited factors is the increase in government subventions and subsidies which had increased purchasing power without a commensurate increase in productivity. That is correct, to an extent, as is evident from chart 1. However, most of these subventions have been static (albeit at high levels) or increasing at much lower rates than they have in the past. For instance, MGNREGA outlays have remained static for the past couple of years. Consequently, inflation arising from the subsequently increased purchasing power should be close to zero. Yes, but there seem to be some changes in the composition of some of these subventions which might have had an effect otherwise. Within the static MGNREGA outlays, for example, the share to unskilled labour rose from 66% of total MGNREGA disbursements (34% to materials and skilled labour) to 78% in the nine months (April-December) of FY13.
Then, there is the contribution of minimum support prices (MSP). Chart 3 shows the co-movements, but unfortunately these do not point to a strong causal relation, even accounting for a year?s lag resulting from the cash income from rabi crops.
Probably one major cause (for which it is difficult to adduce quantitative support) is the increased cash generated from acquisition of rural land, for roads, SEZs, industrial projects, etc. One indirect means of assessing this quantum of cash is through the increase in currency with the public, adjusted for estimated cash required for conducting normal economic activity. These cash balances in circulation, being generated by RBI, are probably one of the most accurate statistics in India. After various judgemental assumptions and algebraic contortions (and cheerfully acknowledged to be only a ballpark estimate), it may turn out that there is about R4 lakh crore more cash in the system than would be warranted by the increase in economic activity since 2003 (which is about the time the real estate boom started), after adjusting for the increase in electronic transactions. We will elaborate on this in a forthcoming article.
If any of this is even halfway correct, what are the prospects for inflation going forward? Unless the rupee depreciates significantly, cost of agri inputs are unlikely to rise in the magnitudes that they had previously done. Also, the increase in MSPs was partly the result of a catchup, which might have mostly played out. Government subventions are also unlikely to increase at anywhere close to what has happened in the recent past. All of this presumes a degree of political stability, which might be a brave assumption, but seems to have a fighting chance of late. Ceteris paribus, there is a reasonable chance that the worst inflationary environment is behind us.
The author is senior vice-president, business & economic research, Axis Bank. Views are personal