RBI should crack down on inflation – S.S.Tarapore

Whatever the vested interests might say, inflation has got out of hand even as 8 per cent growth is still on the cards. The RBI must step up the assault on inflation, before a cold turkey approach becomes inevitable.

Inflation has persisted for over 18 months and is currently in the region of 9 per cent on a year-on-year basis using the Wholesale Price Index (WPI). It was earlier felt that inflationary pressures would, on their own, moderate and all that monetary policy would have to do is take baby steps. In eight policy reviews since April 2010, the RBI undertook seven increases in the repo rate of 0.25 per cent each (on the eighth occasion there was no policy action).  When, in May 2011, the RBI raised the repo rate by 0.50 per cent, there was a broad-based agitation by borrowers (particularly India Inc.), bankers, analysts and the government that monetary policy would be disruptive to growth. In the June review, the RBI reverted to baby steps.

RELENTLESS INFLATION

There are two hazards to baby steps. First, taking inadequate doses of antibiotics over a prolonged period is not only ineffective, but makes the system immune. Secondly, political economy considerations and active lobbies restrict the window of opportunity for policy action.  There is strong advocacy for the view that inflation would dissipate on its own and that no policy action is called for. These expectations have been belied. Inflation has got out of hand and there is no way that it can be talked down by the authorities. The government now argues that anti-inflation measures are inevitable and some growth would have to be sacrificed. A dangerous line of thinking is that there is a new higher ‘normal' for inflation. Such an attitude is a standing invitation for social unrest. With the recent increase in petroleum prices, it is recognised that inflation would accelerate. Dr C. Rangarajan, the doyen among advisers to the government, has categorically stated that in July 2011, the inflation rate could reach 10 per cent and thereafter it would decline. The earlier ‘tolerable' rate of inflation of 5 per cent is no longer being talked about and inflation, at the end of March 2012, is projected at 6.5-7 per cent; there are some analysts who claim that a realistic projection for inflation at the end of March 2012 would be nearer 8.5 per cent. What is particularly relevant is that official price indices understate the ‘true' level of inflation, which, at the present time in India could be as high as 15 per cent per annum. Such a high rate of inflation destroys the socio-economic fabric of the country. The inflation expectations survey by the RBI indicates that inflation would accelerate. While analysts are right in arguing that the government should bear a part of the burden of adjustment, the ground reality is that the central focus of the authorities is on matters other than economic and financial policies.

ONUS IS ON RBI

The historical experience is that when there are difficulties in governance, it is the central bank which holds up the rear. The media has been vociferous that further increases in interest rates will hit credit expansion and growth in the next 12-18 months. Despite talk about a lower pace of expansion of new projects, it is generally accepted that India can easily sustain an 8 per cent real rate of growth. India's growth rate is the second highest in the world, but the inflation rate is one of the highest among the emerging market economies. At the present time, inflation reflects a pressure cooker situation.  The genie of inflation is out of the bottle and suasion cannot be used to get it back in. It would be necessary to twist a few limbs and break a few bones before the genie of inflation gets back under the lid. If the authorities do not take action now, like a drug addiction, inflation will get strongly embedded in the system and the only option would be a cold turkey approach, which would be detrimental to long-term growth.  Accordingly, on July 26, 2011, the RBI should raise the repo rate from 7.5 per cent to 8.0 per cent. Furthermore, to ensure that monetary policy transmission is effective, the banks should be in deficit mode and accordingly, the cash reserve ratio (CRR) should be raised by at least 0.25 per cent to 6.25 per cent. These measures would be the minimum required for monetary correction.  The present repo rate is out of kilter with deposit rates, lending rates and government securities rates. In such a situation the RBI becomes a first recourse for accommodation rather than a lender of last resort. The RBI should take a leaf out of Chinese monetary policy, which has aggressively raised interest rates and reserve requirements even though inflation is much lower than in India. The RBI is in a Catch-22 situation. If it tightens monetary policy on July 26, 2011, it will be pilloried by vested interests. If it resorts to inaction it will be applauded today but will be condemned by history. The choices before the RBI are clear.

HBL

Should We Pick the Microfinance Bill? - M S SRIRAM

The draft microfinance Bill justifies its introduction stating that the microfinance sector lacks a formal statutory framework. This is a fallacious argument parroted by microfinance players asking for ‘regulation’ and thus ‘legitimacy’. Microfinance is no different from consumer/retail finance in form. If we have non-banking finance companies (NBFCs) doing the business of any retail financing, the same framework will work for microfinance. Most MFIs are NBFCs, and are being governed by an appropriate regulatory framework.  The fundamental difference between the NBFCs and the NBFC-MFIs is only about the client base. MFIs serve the poor and the vulnerable and regulation assumes greater significance because of a disproportionate balance of power between the lender and the borrower. If this is recognised then the issue is about client protection more than anything else. The current problems of MFIs have not occurred on account of their registration, capital structure, governance structure. They are on account of the practices at the client end. The draft Bill recognises this issue amidst addressing a many imaginary problems. But the Bill fails to elaborate on how this could be ensured. It goes back to the self-regulatory organisations while assigning some powers to the RBI to take punitive action. This provision of punitive action is available to the RBI as a regulator of NBFCs and it was found wanting in the light of reports of suicides attributed to MFIs in Andhra Pradesh. The last-mile instrumentality in investigating and fixing the responsibility has to be done in consultation with the state governments. The Bill fails to establish this crucial link. The power imbalance between the institution and the client is pervasive. Institutions have greater resources, better support systems and deeper pockets than individuals. In the banking sector, we have seen that the RBI has stepped in to protect the consumers from time to time — whether it was about coercive recovery practices, opaquely loading charges, or guidelines for consumer compensation. The existing regulatory framework could very well have been used for making these interventions. In framing the “improved” version of the Bill, the drafting team has succumbed to the closet agenda of the microfinance sector: (1) microfinance activities of organisations other than NBFCs being given recognition by the RBI, and (2) opening the window for deposit taking from the customers in the name of thrift.  Both need to be examined closely. While trusts, societies and other forms of organisations are engaged in microfinance, they are not appropriate forms to scale. By definition, they carry out charitable activities and are registered under the provincial laws. By making it mandatory for all such organisations to come under its ambit, the RBI is bringing in the aspect of “dual control” that has plagued the cooperative banking sector. The regulatory framework should also recognise the most appropriate form of organisation than take a fait accompli and endorse it.  By prescribing a clause for the compulsory conversion of systemically important MFIs into a Section 25 company, the Bill traverses different legislations where legislations do not permit the unfettered use of residual claims. This forces an organisation registered under a state law to move to a central law. The constitutional propriety of this clause needs deeper examination. The more important issue is of thrift. The draft doesn’t elaborate much. The argument that MFIs should be able to collect thrift/deposits has merit and risk at the same time, which can be weighed by the regulator. The argument for collecting thrift from the customers is valid because, one, the MFI in any case has a network and is in constant contact with the customers and it makes immense sense to provide this service to the poor, and, two, thrift diversifies the funding sources of an MFI, thereby making it less vulnerable to the whims of the commercial banks and will provide them with a greater opportunity to tide over any difficult periods such as the recent Andhra episode after which banks stopped funding MFIs.  But the concerns of the RBI on allowing deposit taking services should also be considered — whether this window will be used by organisations with low capitalisation to collect deposits from a section of the people who technically might not want a loan at that point. This essentially means collecting deposits from “public” and not necessarily borrowers. Talking of a net owned fund base of. 5 lakh to run a microfinance operation and also talk about thrift/deposits is a dangerous trend and the central bank should be wary of this. In all, it appears that what could have been achieved through a policy intervention by suitably reformatting the Malegam Committee recommendations within the existing regulatory framework is being frittered to a new legislation that seems to have conceptual problems.  Also, the draft Bill seems to define everything that is definable but “microfinance”. Can there be a more glaring gap?

(The author is adjunct professor, IIM-Ahmedabad)  ET

Dear FM, your WPI inflation numbers are probably wrong

Inflation in June has probably touched double-digits. The official wholesale prices index (WPI) released on Thursday shows that the annual inflation rate rose from 9.06 percent in May to 9.44% in June, but this is likely to be widely off the mark. Reason: fuel prices were hiked substantially towards the end of June and the second-round effects will show up only gradually. A look at the revised WPI numbers for April tells us why. The provisional WPI number for April showed inflation at 8.66 percent. But the new, revised figure released on Thursday shows a sharp increase to 9.74 percent. That’s a huge difference of 1.08 percent between the provisional and final figures for April. If the final June figure is revised anywhere like what we saw in April, the 9.44 percent is most certainly a gross underestimate and we are already into double-digit inflation. In fact, we may have tipped over into double-digits in May itself. But June and July could really be worse, since we have seen a major hike in petroleum product prices – especially in cooking gas (LPG), kerosene, and the all-important diesel. On 24 June, the government revised the prices of diesel and kerosene by Rs 2-3 a litre, while cooking gas cylinder prices were raised by Rs 50. Since “Fuel and Light” has a weight of nearly 15 percent in the WPI, the chances are that these will be reflected in the revised June numbers and also in July, when the second-round effects of the diesel price hike will also begin to be felt. The latest WPI figure thus comes in well below a Reuters forecast of 9.7 percent rise in June. It also tells us why June should really be higher than what has now been disclosed. For example, the disaggregated numbers show that food inflation has actually risen from 7.61 percent on 25 June to 8.31 percent in the week to 2 July, while fuel shows a fall from 12.67 percent to 11.89 percent during the same week. This means the indices have probably captured the first round impact of the 24 June fuel price hikes, but nothing more. This will happen in July. So what will the Reserve Bank do now? If it takes the June WPI numbers at face value—which it probably won’t, given the recent doubts expressed by Governor Duvvuri Subbarao over faulty data—the next policy review on 26 July will see a 25 basis points (0.25%) hike in the repo rate (the rate at which the Reserve Bank lends to banks). If the RBI assumes that the actual WPI may be in double-digits, as seems likely, it will continue its monetary tightening for a bit more time. The betting is that between now and March 2012, there may be two or three hikes adding up to 50-75 basis points in the repo rate, which means interest rates will peak towards the end of this year. They haven’t yet peaked. Only if the industrial slowdown gets worse—the May Index of Industrial Production (IIP) fell to 5.6%, its lowest since August last year—will the Reserve Bank ease up earlier. So, hold tight. The worst isn’t over.

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FE

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