With the persistent near double-digit headline inflation, despite sustained increases in key policy rates by the Reserve Bank of India, turning out to be “a frustrating experience for policymakers,” senior officials from the Planning Commission, the Finance Ministry and the RBI met with a group of academic economic experts and representatives of the International Monetary Fund (IMF), the World Bank and the Asian Development Bank (ADB) at the National Institute of Public Finance and Policy (NIPFP) here last week to address the policy conundrum.
At the end of the closed-door brainstorming deliberations, during which two broad and divergent points of view emerged, NIPFP Director and Prime Minister's Economic Advisory Council (PMEAC) member Govinda Rao and Chief Economic Advisor Kaushik Basu agreed that “the country's economic managers have not been able to fully grasp the processes underlying the persistence of high inflation.”
And that, perhaps, explains why both food inflation and headline inflation are still raging in near-double digits with no indication of the government being able to contain the price spiral any time soon.
According to the NIPFP, one point of view is that high inflation has persisted because the ‘baby steps' in policy rates implemented by the RBI have been ineffective in anchoring inflationary expectations. This group claimed that there was enough information to indicate that inflation was persisting because of a wage-price spiral driven by inflationary expectations and, therefore, argued that “the RBI should have adopted a shock treatment policy of very sharp interest-rate increases to kill inflationary expectations at the outset of its current monetary tightening policy stance”.
However, critics pointed out that such shock treatment would have simultaneously killed growth also, and triggered a problem of insolvency among debtors. As an example, it was pointed out that such shock treatment by the then United States Federal Reserve chairman Paul Volcker, in the early 980s, successfully curbed inflation in the U.S. but at the same time generated the Latin American debt crisis.
‘Rate hikes could be counterintuitive'
Dr. Basu said that under these equilibrium market conditions, interest rate changes could lead to counterintuitive outcome, and cited the case of Turkey, where interest rate reduction had reduced inflation. He had made this point prior to the RBI rate hike on September 16 too. But the RBI went ahead with yet another ‘baby step' — a hike of 25 basis points in the repo rate.
Case of Turkey
Incidentally, analysts say, the Turkey step succeeded in checking inflation, primarily as it was aimed at disincentivising huge foreign capital inflows.
The alternative point of view articulated by economist Mihir Rakshit was that inflation in India in the recent period had been of the cost-push variety, arising in particular sectors, and not attributable to a generalised excess demand. This view, however, had a few variants in that cost-push inflation was mainly attributable to generalisation of food price increases arising from demand-supply imbalances in agriculture.
While Professor Rakshit's paper also pointed out that headline inflation and core WPI (Wholesale Price Index) inflation were not correlated with food price increases, an alternative hypothesis argued that cost-push inflation was being driven by high global commodity prices — of oil, metals, food, etc. In short, India was experiencing imported inflation, which could not be easily tackled with aggregate demand compression policies such as interest rate increases.
According to Professor Rao, there was also a general consensus that transitional inflation arising from a one-time adjustment in oil prices would largely work itself out within a year and should not be addressed with an overall inflation management policy.
There was also agreement that food price increases arising from demand-supply imbalances pointed to the urgency of medium-term measures to improve productivity and efficiency in the agricultural sector.
Non-availability of data
The participants also noted that “inflation analysis is being seriously constrained by non-availability of key high frequency data on output gap, employment, wage rate, de-seasonalised price indices, etc,” the NIPFP note said.
The net result — the reasons for inflation are known and analysed, the common man continues to bear the brunt of spiralling prices and the policy conundrum continues with no sign of light at the end of the tunnel.
