On September 16, the RBI raised its repo rate (the rate at which it lends to banks) by 25 basis points to 8.25%. A similar 25 basis point hike was announced in the reverse repo rate ( the rate at which it pays banks for deposits). This latest increase marks twelve successive rate hikes over the last eighteen months in a bid to dampening spiraling inflation. While the Eurozone is suffering from a sovereign default crisis and the US from spiraling public debt, India's problem is to do with galloping inflation. With the Wholesale Price Index (WPI) stood @ 9.78% in August, India has the fastest rising inflation factor in the so called BRIC economies. Basically inflation is nothing but an increase in general price levels in the economy.
Now, it is basic common sense that prices will reduce either when demand falls or when supply increases. Since our government seems to lack the political will to free clogged up supply, it is forced to adopt the other ( less desirable) solution - arrest demand. This it has done by tightening interest rates and making money supply dearer. They hope that higher rates will halt the demand- push price rise and thus help arrest spiraling inflation. However, this strategy comes at a cost. Higher rates also translate into lower growth. Capital is the lubricant that commerce functions on. When capital becomes expensive, industry in general is forced to slow down. Expansion plans or fresh commercial activity is naturally put on hold. Existing earnings get diluted on account of the higher input cost and interest outgo. Already, F 11- 12 earnings estimates for India Inc are down to single digit. Lower earnings translate into lower stock prices. The stock market downturn in turn would mean that the government will be forced to take pullback or postpone its proposed disinvestment program thereby further affecting the already worrisome fiscal deficit situation. The domino effect, as it were, doesn't end here. At the retail level too, due to transmission of the policy rates, the outgo on consumer, auto and housing loans increases. However, food inflation, which is causing the most distress and of prime concern to the common man cannot be influenced only by monetary policy. Simply because it is not so much an increase in demand as much as a constraint in supply that is the main cause of the problem. While it is true that schemes such as NREGS (National Rural Employment Generation Scheme) as well as the Sixth Pay Commission wage hike has indeed augmented overall disposable income in rural India, the more immediate causes of skyrocketing prices are the distribution bottlenecks as well as manipulation, in food supply. For example, it is common knowledge that the producer/ farmer gets a small fraction of the price that the end consumer ends up paying with the middlemen pocketing most of the difference. In the meanwhile, the supply chain is laughing all the way to the bank. The irony is that the government only knows too well what needs to be done. Tonnes of food grain rots in government warehouses for lack of proper storage and distribution facilities. The loopholes in the PDS (Public Distribution System) are well documented. Organized retail would benefit the farmer as well as the consumer. Unfortunately vote bank politics has taken precedence over reforms in a sector that is in dire need of improved infrastructure. Rupee Depreciation The other issue which is complicating the situation further is the falling rupee. Though currency fluctuation is beyond the control of the government, the fact remains that a fall of nearly 10% over the past couple of months has seen the rupee drop to almost Rs. 50 to a dollar. This has essentially happened on account of a heightened perception of sovereign risk across the eurozone resulting in an across the board appreciation of the US dollar against most international currencies. Thankfully, a simultaneous drop in global commodity prices is partly offsetting the negative impact of an expensive dollar - but largely a depreciating rupee will only go towards inflating the value of imports. Manufacturers would typically pass on the price rise to the consumers further fuelling the price rise.
To Sum Apart from attempting to unclog the supply side constraints, the government could also have helped itself ( and consequently the common man) by adopting some financial discipline. The largest component of discretionary expenditure is on subsidies on food, fertilizer and petroleum products. As per the RBI Governor himself, in reducing these subsidies, there is inevitably a tension between democratic compulsions and economic virtue. However, vote bank politics comes in the way. Though the official speak is that the effects of monetary policy manifest with a lag, it's already over 18 months and 12 hikes, with more in the offing. So far, the tightening has not had the desired effect on inflation - all it has resulted in is the stifling of growth. All eyes are now on October 25 when the Central Bank will announce its policy for the second quarter. In the previous monetary review, the RBI view is that any change in the policy stance would dilute the impact of past policy actions. So unless there were firm signs of downward movement in the inflation trajectory, it would be imperative to persist with the current anti- inflationary stance. Be that as it may, unless the leadership shows political determination and the ability to look at the big picture, no amount of tinkering with the rates are going to solve our problems. APART from unclogging the supply side constraints, the government could also have helped itself (and consequently the common man) by adopting some financial discipline.
FPJ
