RBI right in wanting govt action, but it's stand of no help
On the face of things, you can’t blame RBI for not cutting policy rates since, as it says, the government has done precious little to either remove supply-side constraints or to improve fiscal consolidation, both vital to keeping inflation under check. The fact that the government continues to dither over raising diesel prices, and didn’t allow oil PSUs to fully raise prices of even the decontrolled petrol for close to two years, makes it clear the year’s subsidy targets are going to be vastly exceeded—with GDP likely to be much lower than projected, and taxes commensurately lower, this is a certainty. As for supply-side problems, the fact that the current bout of inflation is almost entirely driven by fruits and vegetables, not just proteins, makes it abundantly clear where the problem lies. On a annualised basis, prices of fruits and vegetables rose 179% in the three months to April, a BNP Paribas analysis shows—and prior to this, they fell 38% on an annualised basis for the three months leading to January! It hasn’t helped that the government just raised procurement prices dramatically, a move that generally leads to higher inflation—MSPs have been raised 15-16% for rice, 33% for oilseeds, 30% for pulses and 53% for coarse grains.
But that said, what are we to make of the policy? Rate cuts cannot, as RBI argues, raise GDP growth if the problems are structural or if there is, to use the common catchall phrase, ‘policy paralysis’. But rate hikes make viable projects unviable by lowering project IRRs and, by the same logic, rate cuts make them viable. If structural problems were as severe as made out by those against rate cuts, investments wouldn’t be growing the way they are—of course, rates of growth have fallen, but investments are taking place nonetheless. In March 2012, CMIE says, projects worth R1,82,800 crore were completed versus R1,25,000 crore in March 2011. In any case, the point is RBI hiking rates hasn’t really helped control inflation which is largely driven by supply-side issues—is RBI’s policy, combined with that of the government, just leading India more steadily into stagflation?
What makes matters confusing is that while RBI focused on a modified version of core inflation till now, suddenly it is CPI inflation it is talking about, and worrying the reduction in WPI is not getting translated to CPI—since the difference between WPI and CPI is high, and increasing (see charts in the adjoining column, “Inflation’s pulse”), this suggests rate cuts may not take place for a long time! It speaks volumes for RBI-speak that a deputy governor spoke of lowered crude prices offering scope for rate cuts just a few days ago. Equally confusing are the statements about how, since real interest rates were higher in the high-growth 2003-08 years, interest rates have a limited role in explaining today’s lower growth. India’s 2003-08 growth was surely lifted by much higher global growth and consequent higher imports; if local interest rates were high in 2003-08, India Inc was mitigating this by raising large sums in local equity markets (R52,200 crore in FY08 versus R24,000 crore in FY12) and overseas markets. RBI is caught between not wanting to raise rates in the belief this will curb inflation, and not wanting to be seen to be hitting growth—an unenviable position.