Government intervention prevented the sharp oil-driven peak in global food prices from reaching us, but now we are in our usual lagged catch-up as inflation falls elsewhere. The lag needs to be reduced now, says Ashima Goyal.
INDIAN green shoots are becoming more robust. But even if we reach 7% growth this year, it will be below a conservative potential growth estimate of 8%. Yet food price inflation is high, creating a dilemma for policy. Growth has still to be encouraged until it reaches capacity and a robust new investment cycle is established. But food is a large part of the average consumption basket and high prices impact the common man.
Month-to-month food price inflation showed some reduction, but rose again in August as the rains failed. Post the festival season and with the late revival of rains, the current spike could moderate. So should policy wait out the current inflation In 1998-99 not tightening monetary policy when inflation peaked with food prices worked as inflation fell later.
But food prices do affect wages, costs and inflation down the line, as inflationary expectations enter prices being set today. There has been some rise in manufacturing prices also in the past few months. Therefore there is a need to anchor inflation expectations. But how best to do this?
Should liquidity be reduced Or some of the quantitative easing measures reversed The liquidity adjustment facility is absorbing large amounts of liquidity, which is not yet percolating into the real sector where it is required. It follows that excess liquidity is not the problem. Credit growth remains low at around 13%. Asset bubbles normally rise only if credit growth is excessive. And the instrument of procyclical prudential requirements is available to moderate them. If credit is going too much in any one direction concentration margins can be charged.
In China, credit is growing at 34%, financing not just government investment, but also private housing. Each house needs to be equipped, and given the large population, it generates a lot of demand. So Chinese growth may be sustainable, and they may avoid asset bubbles. We have a similar large population. Low interest rates and easy liquidity facilitate the supply side response we require to grow and to control inflation.
Communication from the Reserve Bank of India may help control inflationary expectations, if markets and the public are clearly educated on the difference between cost shocks and excess demand driven inflation. In addition, giving an expected inflation rate, announcing an acceptable range of inflation, may help underling the lower levels of inflation we have got used to. Although the RBI communication has improved, it has had poor success in forecasting inflation. The definition and measurement of Indian inflation is unsatisfactory as yet. Therefore, communication to be credible some action is required to back it.
One signal of serious inflation watch is increasing the repo rate or rate at which the RBI lends to banks by 0.25 basis points. Since there is little borrowing from the RBI at present, it will have minimal effect on credit availability and price, but will signal a concern about inflation . The yield curve is steep currently, partly because of fears of inflation. A mild rise in the repo rate may actually help calm such fears and improve the transmission allowing lower short rates to successfully reduce long rates and loan rates. As banks expect rate rises it would be profitable to shift from holding government securities to making loans.
EXIT , whenever it occurs, must be very gradual, since banks pass on rate rises faster. So the tug on the string should be mild. The RBIs mild rate rises from 2004 did not reduce growth, but the steep rise in 2008 did. A stitch in time saves nine. If inflation moderates a mild rate rise can be reversed, and the structure of Indian interest rates can stay at the lower levels the crisis has enabled. If a further rise is required it can continue to be mild if it starts now.
Liquidity is high internationally, yet leverage is lower after the collapse of many investment banks. But there is little progress on financial reform. If inflows surge as they did in 2007 more restraints may be required on the types of inflows susceptible to wider interest differentials. Indias intermediate stage of capital account convertibility gives it some degrees of freedom in managing, despite an unsatisfactory international financial architecture . Equity inflows do help Indian companies investment plans.
Another instrument to moderate inflation is more short-term appreciation of the nominal exchange rate. Inflows are strong because of better Indian prospects. The Reserve Bank has not intervened so far. If it continues to refrain from intervening in the forex market, the rupee will appreciate further. Appreciation above equilibrium values may allow Indias interest rate to be higher than in the US while discouraging inflows through different types of carry trade, since depreciation would be expected in future. With excess capacity, inflation is low in most countries in the world. We should be able to import these low international prices. If we do not abort inflation now, there will be real appreciation anyway from higher domestic inflation.
The exchange rate cannot substitute for depressed world trade conditions, which will continue for sometime, so it makes sense to encourage some substitution towards domestic demand. The majority of Indian exports continuing to do well are niche exports that are not so price sensitive. But, over the long run, a competitive real exchange rate is required since India has a current account deficit in the balance of payments.
A fiscal policy alternative to exchange rate policy is tariff cuts on food price items. This together with the absence of elections in the next year may prevent further procurement prices increases. Low world inflation did help bring down Indian inflation rates in the nineties. Government intervention prevented the sharp oildriven peak in global food prices from reaching us, but now we are in our usual lagged catch-up as inflation falls elsewhere . The lag needs to be reduced now.
(The author is professor, Indira Gandhi Institute of Development Research, Mumbai)
http://lite.epaper.timesofindia.com/getpage.aspx?pageid=8&pagesize=&edid=&edlabel=ETD&mydateHid=24-10-2009&pubname=&edname=&publabel=ET
No comments:
Post a Comment