Tuesday, September 13, 2011






This Blog had always held that RBI Rate Hiking Policy cannot by itself control the Inflation. In the last Post on the subject at the URL : http://wiseinvestmentideas.blogspot.com/2011/06/rbi-mid-quarter-monetary-policy-review.html      - this blog had commented as follows :

On june16th,2011

The RBI’s monetary Policy reviews are always highly logical, consistent and well reasoned. As we can see from the above Points from the RBI Review dated 16th,June,2011 – RBI has taken into account Global developments, local developments, money supply, inflation, growth conditions etc – and with them, supports its Policy prescription.
In the circumstances stated by RBI, the hiking of the repo rates is perhaps unavoidable.
But then – what are the other salient aspects we need to take note of from the review?

1. Global economic conditions : There is an implicit assumption – that global inflation will reflect in India too – automatically. This is not necessarily true. Even in respect of Oil and its related products – India has a system of absorbing the additional expenditure at the central level (to some extent) and passing on a part of the additional expenditure on account of oil price hikes into the Indian markets. This, in my view, is quite healthy. Central funding of the additional Oil Bill – is any way coming from taxes, and is indirectly borne by the people only. But, the inflation on this account is not spread to all commodities with huge spiraling effect. Which Global Products will affect Indian purchases? Capital Goods, computers and the like – whose share in Inflation is pretty little.
2. Indian Conditions – Food Inflation : Food articles are in  Inflation spiral – more because of logistical, warehousing and other inefficiencies and not much due to shortages compared to Demand. Where shortages appear periodically like in edible oils, long term measures like increasing acreage and short term measures like Imports are called for.
Now Tamilnadu has started supplying food grains  FREE at its PDS outlets – which is laudable. The effect of such measures will be effective control on Food Inflation. Other states also can adopt the same – instead of allowing the food grains to rot in FCI Godowns. If supply mechanism is streamlined, even other food articles prices in the markets will come down significantly.
There are many items like Sugar and a few other food items – where there is no shortage. In such cases, the respective Ministries need to move in quickly to control prices.
3. Indian Conditions – Non-Food Inflation : Oil Price hikes are bound to result in an all-round inflation spiral in many products and services. Inflation will not be limited to the percentage increase in Oil prices.
Increase in iron Ore prices, rubber prices and such other raw material prices – have their cascading effect on steel prices, manufactured article prices etc. If raw material prices are controlled – by stopping exports, improving imports, bringing in additional acreage (for rubber, Cotton,  other plantations etc), Non-food inflation will come down.
4. CSO Statistics : It is heartening that CSO has updated its statistical Indices. While this is a matter for satisfaction - there is also need to improve the statistical collection methodologies and machinery,  and further improve collation and computational methods, using latest software programs - as the monthly variations in manufacturing indices do not seem to be logical – even now.
5. Credit Growth : Credit Growth is bound to be there, in a growing economy – even in the face of high interest rate regime.
But, sectors like automobiles, consumer durables are showing slower growth.
Several manufacturers have not fully passed on  their increasing raw material costs, as we can see from their decreasing profitability curves (Like Maruti, TATA Motors etc).So, prices of manufactured products are not going up at the speed suggested by Inflation numbers.
Banks have of course responded well to all RBI rate increases – by increasing their own lending rates – and they have also kept their borrowing rates rising steadily, keeping their own profit margins steady.
Credit today is considerably dearer compared to the beginning of FY 2011 – and is likely to affect small and medium scale industries; loans on automobiles, house-purchases, consumer goods and a few other sectors.
6. Liquidity Conditions : While this is RBI numbers – the invisible money in circulation distorts all sorts of calculations.
All in all – the RBI Policy prescription is in expected direction only. It is however essential that the state and central Ministries must also come out with strong Policy measures to counter Inflation – and support these RBI measures to become effective.


Now – the latest stand of the Government that Rate Hike strategy is not working but is hurting Growth – is a very Late realization. RBI’s Rate Hike strategy never worked in the last 2 years. The reasons are very clear. This inflation is not one which is guided by high liquidity in the system chasing too few goods. If this were the case, RBI strategy would have worked.
But, this has not been the case. Goods were not scarce. Taking the Food Inflation into view – it was mainly due to the inaction, delayed actions and wrong actions of the central and state Ministries concerned.
This has not been set right. Food Inflation has been the main component of the overall Inflation in India. Yet, how many meetings of the Food and agriculture Ministers and secretaries was there on this point? How many expert committees were constituted to deal with this aspect? How many raids were conducted on hoarders? How much imports were made and exports cut down in respect of food items in short supply? How much additional acreage has been brought into use for products in short supply?
How much of godown space has been increased? How much food grains with Government were released into market to counter inflation?
All these factors can help control food Inflation. But, then, this initiative is with Government – not with RBI. There is absolutely no point in finding fault with RBI’s monetary policy measures for containing Inflation. The general perception is – Government was expecting the RBI – and only the RBI – to produce some magic wand to contain Inflation.
But, other than Rate Hike, RBI has no other medicine in its kit – and this medicine is not useful at all – when the inflation is not due to liquidity in the system but is due to other factors which are in the area of control of the Government.
It is like administering aspirin for AIDS –because aspirin is the only medicine in the Physician’s Kit. The AIDS specialist must be woken up, called out and asked to act. This is what is needed for food Inflation.
OIL PRICES : For non-food inflation, it was always wrong to inflate the oil prices and expecting that it will not result in spiraling inflation. It will. On the other hand, it is always better to absorb the temporary increases in oil prices and increase the taxes in general – to that extent – which then will remain largely non-inflationary.
CSO STATISTICS : Though CSO has modified its statistics, still doubts persist. There is need for an experts committee – drawing from the Government, the RBI, the Industry and the CSO itself – to study the present Index, the methodology of its compilation, the level of accuracy and the scope for errors – and take measures for better compilation. It must be computerized totally.  
GROWTH : While RBI’s monetary Policy – increases in Rates – has not helped to contain inflation, it has certainly helped to stifle growth. This was anticipated even earlier. Even RBI’s reviews do look at this point. India cannot afford to stifle its growth momentum on any account. India has not grown to a level where it can afford to go slow on this point. Mr.Kaushik Basu is very right on this point.
SO WHAT NOW : If Rate Hikes in the past was a wrong prescription, evidently, there is a need to slowly reverse it on the one hand, and, also, go for the right prescription. The central and State food and Agriculture Ministries will need to look at serious measures to avert food scarcities and food inflation. We must recognize that we can live with glut and not with scarcities in food articles. Governments must plan to achieve surpluses – and compensate formers suitably where the produce cannot be sold fully. We can even supply to other starving countries free or at heavily subsidized rate – and there are many such countries who will be grateful to us.
In any case, a further dosage of the wrong prescription, however small it is, is uncalled for. We do look for a reversal of Rate Hikes – so that Growth momentum restarts. The Indian manufacturing Industry and the Indian stock Markets are in doldrums mainly due to this one reason.

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