No point killing GDP when even CPI-sans-veggies down
Given how the relatively muted WPI inflation of FY10 quickly became full-blown double-digit inflation in FY11, it is not surprising that the central bank has become even more focused on nipping inflation in the bud, a stance that RBI Governor Raghuram Rajan has reiterated on various occasions after taking over. And since both CPI and WPI are inching up once again, smart money has it that Rajan is going to follow up his last repo rate hike with another one tomorrow. But what RBI needs to keep in mind is that in FY10, growth was on an elevated trajectory—from 3.5% in the March 2009 quarter, GDP rose to 5.9% in June and 9.3% in September before falling a bit to 7.7% in December and then rising again to 11.4% in March 2010. Through FY11 also growth averaged 9.3%, with the lowest of 8.6% in Q2. In contrast, growth fell from 4.8% in March 2013 to 4.4% in June 2013; while PMI has been slowing for many months, it has been contracting for the last two, something that last happened in March 2009. Interestingly, as our columnist Renu Kohli pointed out last week after examining the WPI-repo relationship over two decades, the policy rate has always been higher than WPI—when it became lower, as it did towards the end of FY10 and in FY11, when growth was also picking up, inflation got entrenched. This, however, is not the case now with the repo a full percentage point above WPI and growth on a declining trajectory.
Disaggregate inflation data further, and the picture gets even starker since a large part of the hike, especially in the case of the CPI, is solely related to soaring prices of fruits and vegetables, eggs, milk and other such higher-value agriculture products. The hike in such inflation, however, is something RBI’s monetary policy can do little about; it is a larger supply-side issue and raising interest rates further will only hurt growth while not being able to tackle inflation. Between FY91 and FY01, per capita GDP rose over 3 times, and it rose 3.13 times in the next decade; and between FY10 and FY12 it rose 33%. Between FY91 and FY01, however, production of fruits and vegetables rose 1.5 times and by 1.7 times in the next decade; between FY10 and FY12, production of fruits rose just 5.3% and that of vegetables 12.6%. Under normal circumstances, the yawning gap may not have mattered. But as people get richer, their food habits change. At an all-India level, between FY05 and FY12, food consumption is down from 40% of private consumption to 31%; in even among the priority group the Food Security Act talks of us in rural areas, just 35.2% of food expenditure is on cereals like rice and wheat, 12.7% is spent on vegetables, 11% on milk and milk products and 7.5% on pulses. Governor Rajan needs to keep this in mind along with the fact that in FY12, of the gross fixed capital formation of 30.6% of GDP, almost 45% came from small and mid-sized companies, what is called the household sector—high interest rates are the surest way of killing this investment which, it has to be added, is not being stopped due to the lack of environment and other such clearances that dog large investments.