Inflation’s back is broken, what is RBI waiting for?
The central bank has traditionally given several reasons for hiking interest rates or keeping them that way, and they ranged from high oil prices to high fiscal deficits and high inflationary expectations that needed to be anchored. Later, when the new RBI Governor came in, CPI inflation targets got added to this list. Most, if not all, of these reasons for a status quo on interest rates no longer exist. At $82 per barrel, oil prices are at their lowest in four years and few expect them to recover in a hurry with global demand not rising anywhere near as fast as expected, and OPEC in tatters thanks to the dramatic hike in US production levels—indeed, with diesel prices already at market rates, and falling, the danger of suppressed fuel inflation waiting to flare up in India seems remote at this point. As for food items, bumper harvests globally have led to a sharp fall in prices of most major crops, by around 20% in just the last 6 months; it helps that, apart from finally taking a decision to offload 10 million tonnes of FCI’s wheat stocks in the open market to dampen foodgrain prices, the government is also keeping MSP hikes to the minimum.
High fiscal deficits, cited as a major reason for increasing demand levels and inflation in the economy in the past, haven’t been an issue for well over a year now; indeed, some argue the government needs to go easy on this in order to stimulate the domestic economy.During the last few months when the fall in inflation levels have been particularly savage—from 8.8% in January, CPI inflation is down to 6.5% in September, and core CPI from 8.1% to 5.9%—it has to be pointed out, effective borrowing rates have actually fallen with banks rushing to cut spreads for good borrowers and commercial paper and other rates also falling in the absence of any demand for funds. In other words, it is difficult to argue that monetary policy had much to do with inflation falling. The fact that the central bank’s inflationary expectations survey showed 3-month forward inflation rising from 12.9% in March (this is the inflation prediction for June when the actual was 7.5%) to 14.6% in September (this is the inflation expectation for December 2014) when inflation was collapsing makes it pretty clear the inflationary expectations survey—and the bit about inflation expectations getting embedded—doesn’t really add up to much.
But what if, it is argued, the oil price collapse is just a one-off, or that global food prices start rising again? Does the central bank want to be caught cutting rates one day and hiking them another? Put that way, it seems logical. But the important thing to keep in mind is that central banks work on broad probability of events, not on Black Swan probabilities. Right now, no one is looking at the oil or other commodity cycle turning for another year or so. And with the government keeping a lid on expenditure and trying to clear as many supply bottlenecks as possible, it is difficult to understand how RBI Deputy Governor HR Khan can feel inflation still has a long way to go.