Rising prices are affecting millions of people throughout the country. Inflation has hit the poor and the poorest the hardest. Ours being predominantly a rural nation needs to address issues concerning the largest section of the society on priority. Skyrocketing inflation numbers which crossed 7% recently has put considerable pressure on many families. The official inflation numbers based on wholesale price index is not the actual measure of the kind of pressure experienced by families across the length and breadth of the nation. A more realistic measure namely the consumer price index (Which is the official measure of inflation in many western countries) is considerably more than WPI. Further, the absolute inflation measured in terms of individual prices of essential commodities is well above the official WPI and CPI inflation.
The situation can get complicated if food and cash crop do not register a significant increase compared to 2007-08. (production of wheat in 2007-08 was more than 2006-07).The un seasonal rains in southern India and accompanying loss of crops in many parts of Karnataka ,Tamil nadu,Andra Pradesh and Maharashtra in recent weeks is likely to put considerable pressure on production of pulses. If this case emerges, large scale imports of pulses will become inevitable.
Indirectly, inflation is the cause and effect of Inflation. Higher inflation will put pressure on RBI to increase CRR which will harden interest rates. The recent hike in CRR to 8% will only add up to the higher interest rates of the bank. The higher interest rate will buttress the capital inflow from outside the country particularly from countries with low interest rates. This will further add up to liquidity in the system resulting in inflation. This is exactly opposite to what the doctor ordered. The RBI will again have to resort to hike in CRR or in open market operations. For more than a year now, the RBI is resorting to hiking CRR at regular intervals and also running out of government securities. This is not a very healthy sign for the road to capital account convertibility. So the RBI is caught up in the vicious circle of sterilization-capital inflow-sterilization. In other words, an increase in interest rate is bringing more capital flows, to stop this capital’s entry into the system, the RBI increases CRR which will again bring in more capital.
Moreover, the high Repo rate regime is not helping control inflation either. The relative ease with which the business and international banks can borrow funds from outside the country with lower rate of interest is not putting any pressure on commercial banks to borrow from RBI. This technique inevitably brings in foreign exchange leading to excess liquidity, fuelling inflation and making the rupee dearer vis-à-vis dollar.
Of course the RBI is doing whatever it can from the monetary policy point of view. CRR is the most powerful tool available with RBI to reduce velocity of money. But one must understand here that CRR has very marginal influence on food prices which in the greatest economic problem engulfing us. Hike in CRR may at best prevent people from borrowing for luxury goods, high end technology and real estate. (Human appetite is not a function of quantity of money; people will not eat more if they have more money). Hike in CRR is only going to put brakes on our industrial production with only a notional impact on lowering food prices. Moderate inflation in industrial products is not a grave concern now. In fact Inflation of about 6 to 7% in industrial goods will create Employment, Boost industrial production and bring capital.
It’s high time that government focused on Inflation numbers for agricultural products, essential goods and overall food basket.
Another burning issue is that of agricultural land. Of what use are cars and bikes if 400 million people in our country cannot get one square meal a day? It’s high time for government to reconsider its Industrial policy (SEZ policy).
Intercropping, Soil conservation, Afforestation, agricultural research and pest management must be given fillip and government needs to invest in these areas on priority along with NREGA and female education.
It is estimated that subsidies on select petro products in 2007-08 are likely to exceed 60,000 crores. Also, the supply constraints due to inadequate output of Wheat, Pulses and Edible oils will fuel inflation if imports in required quantities cannot be secured. Inadequate supply of essential products coupled with high crude prices may push the whole sale price index inflation to over 10%.
A stronger rupee will make our imports cheaper. Inflation targeting becomes much easier with a stronger rupee. If the RBI intervenes in the exchange rate market, it would actually be hampering the inflation curbing process. RBI certainly needs to protect our exporters, but its intervention to contain the appreciating rupee will be desirable when inflation (particularly primary goods prices) becomes sustainable and supply side of essential commodities augmented.
Most of India’s export earnings are trough software and services. Businesses of these goods and services operate at greater profit margins. So an appreciating rupee must not hurt their profit margins to alarming levels as compared to alarming levels of inflation hurting millions of people.
Dr Y.V.Reddy, governor of RBI in his inaugural address at a conference on advances in open economy macroeconomics held on 19 March 2007 in Mumbai said “If the domestic inflation rate of an economy, however low it may be, is higher than the average inflation rate of its trading partners, it puts pressure on exchange rate. In this context, the question of simultaneous balance of internal and external sector becomes a major issue if flexibilities in the economy are less than adequate. The conduct of monetary policy inevitably involves a careful judgment on relative weights assigned to domestic and global factors and conduct reassessment and rebalancing of these in response to evolving circumstances.” We must note here that India’s inflation is more than double compared to our primary trading partners (U.S.A and U.K). Commensurate with this our central bank should keep itself away from the exchange rate market. On the longer run the market forces will automatically take care of the exchange rate once the inflation difference between trading partners reaches manageable levels and movement of funds across seas stabilizes.
It’s worthwhile to note here that the export earnings of India contribute to about 13 to 15% of GDP. The monetary authorities should not hurry up and express great apprehensions over appreciating rupee.
At the moment its better that RBI keeps itself away from the exchange rate market and allows the market forces to operate. RBI would do well to shed off its obsession over CRR and look for alternatives. RBI must cajole banks to provide credit for agricultural activities.
Its time the RBI takes a serious look at its foreign exchange stocks. Investing a part of this reserve for revamping rural infrastructure in definitely a viable option given our strong macroeconomic fundamentals
To conclude, RBI and other fiscal and monetary authorities must devise a scheme to distinguish food inflation from Inflation per se, move away from traditional instruments, come out of the vicious circle of Sterilization-Capital inflows-sterilizations and creatively use the inflowing capital as real capital to fuel the growth of Emerging and enlightened India.
[Letters published in the Hindu Businessline on the subject http://www.thehindubusinessline.in/2008/05/15/stories/2008051550160803.htm
The situation can get complicated if food and cash crop do not register a significant increase compared to 2007-08. (production of wheat in 2007-08 was more than 2006-07).The un seasonal rains in southern India and accompanying loss of crops in many parts of Karnataka ,Tamil nadu,Andra Pradesh and Maharashtra in recent weeks is likely to put considerable pressure on production of pulses. If this case emerges, large scale imports of pulses will become inevitable.
Indirectly, inflation is the cause and effect of Inflation. Higher inflation will put pressure on RBI to increase CRR which will harden interest rates. The recent hike in CRR to 8% will only add up to the higher interest rates of the bank. The higher interest rate will buttress the capital inflow from outside the country particularly from countries with low interest rates. This will further add up to liquidity in the system resulting in inflation. This is exactly opposite to what the doctor ordered. The RBI will again have to resort to hike in CRR or in open market operations. For more than a year now, the RBI is resorting to hiking CRR at regular intervals and also running out of government securities. This is not a very healthy sign for the road to capital account convertibility. So the RBI is caught up in the vicious circle of sterilization-capital inflow-sterilization. In other words, an increase in interest rate is bringing more capital flows, to stop this capital’s entry into the system, the RBI increases CRR which will again bring in more capital.
Moreover, the high Repo rate regime is not helping control inflation either. The relative ease with which the business and international banks can borrow funds from outside the country with lower rate of interest is not putting any pressure on commercial banks to borrow from RBI. This technique inevitably brings in foreign exchange leading to excess liquidity, fuelling inflation and making the rupee dearer vis-à-vis dollar.
Of course the RBI is doing whatever it can from the monetary policy point of view. CRR is the most powerful tool available with RBI to reduce velocity of money. But one must understand here that CRR has very marginal influence on food prices which in the greatest economic problem engulfing us. Hike in CRR may at best prevent people from borrowing for luxury goods, high end technology and real estate. (Human appetite is not a function of quantity of money; people will not eat more if they have more money). Hike in CRR is only going to put brakes on our industrial production with only a notional impact on lowering food prices. Moderate inflation in industrial products is not a grave concern now. In fact Inflation of about 6 to 7% in industrial goods will create Employment, Boost industrial production and bring capital.
It’s high time that government focused on Inflation numbers for agricultural products, essential goods and overall food basket.
Fiscal the only alternative:
We must understand that Inflation is not only a monetary phenomenon. Inflation targeting must be done from both monetary and Fiscal platforms. On the fiscal front, the government must first ban future trading in essential commodities, ban retail traders from getting listed in stock markets and floating shares No effort must be spared to track and punish hoarders. Government will do well to revive the PDS system and dispense the notion of BPL beneficiaries and provide food for all.Another burning issue is that of agricultural land. Of what use are cars and bikes if 400 million people in our country cannot get one square meal a day? It’s high time for government to reconsider its Industrial policy (SEZ policy).
Intercropping, Soil conservation, Afforestation, agricultural research and pest management must be given fillip and government needs to invest in these areas on priority along with NREGA and female education.
Role of RBI:
It is estimated that subsidies on select petro products in 2007-08 are likely to exceed 60,000 crores. Also, the supply constraints due to inadequate output of Wheat, Pulses and Edible oils will fuel inflation if imports in required quantities cannot be secured. Inadequate supply of essential products coupled with high crude prices may push the whole sale price index inflation to over 10%.A stronger rupee will make our imports cheaper. Inflation targeting becomes much easier with a stronger rupee. If the RBI intervenes in the exchange rate market, it would actually be hampering the inflation curbing process. RBI certainly needs to protect our exporters, but its intervention to contain the appreciating rupee will be desirable when inflation (particularly primary goods prices) becomes sustainable and supply side of essential commodities augmented.
Most of India’s export earnings are trough software and services. Businesses of these goods and services operate at greater profit margins. So an appreciating rupee must not hurt their profit margins to alarming levels as compared to alarming levels of inflation hurting millions of people.
Dr Y.V.Reddy, governor of RBI in his inaugural address at a conference on advances in open economy macroeconomics held on 19 March 2007 in Mumbai said “If the domestic inflation rate of an economy, however low it may be, is higher than the average inflation rate of its trading partners, it puts pressure on exchange rate. In this context, the question of simultaneous balance of internal and external sector becomes a major issue if flexibilities in the economy are less than adequate. The conduct of monetary policy inevitably involves a careful judgment on relative weights assigned to domestic and global factors and conduct reassessment and rebalancing of these in response to evolving circumstances.” We must note here that India’s inflation is more than double compared to our primary trading partners (U.S.A and U.K). Commensurate with this our central bank should keep itself away from the exchange rate market. On the longer run the market forces will automatically take care of the exchange rate once the inflation difference between trading partners reaches manageable levels and movement of funds across seas stabilizes.
It’s worthwhile to note here that the export earnings of India contribute to about 13 to 15% of GDP. The monetary authorities should not hurry up and express great apprehensions over appreciating rupee.
At the moment its better that RBI keeps itself away from the exchange rate market and allows the market forces to operate. RBI would do well to shed off its obsession over CRR and look for alternatives. RBI must cajole banks to provide credit for agricultural activities.
Its time the RBI takes a serious look at its foreign exchange stocks. Investing a part of this reserve for revamping rural infrastructure in definitely a viable option given our strong macroeconomic fundamentals
To conclude, RBI and other fiscal and monetary authorities must devise a scheme to distinguish food inflation from Inflation per se, move away from traditional instruments, come out of the vicious circle of Sterilization-Capital inflows-sterilizations and creatively use the inflowing capital as real capital to fuel the growth of Emerging and enlightened India.
[Letters published in the Hindu Businessline on the subject http://www.thehindubusinessline.in/2008/05/15/stories/2008051550160803.htm
