inflation in india

India has a proud record on inflation. Between independence in 1947 and 2000, prices rose in double digits only 21% of the time, mainly during the oil shocks of the 1970s. Accepted wisdom is that inflation hurts the poor most and, since most people are poor, can quickly lead to a backlash. “Price rises in India have ignited student riots, nationwide demonstrations and government collapse,” writes Nandan Nilekani in his bestselling book, “Imagining India”.

That logic may soon be tested. Like most emerging economies, India has slowed; unlike them, inflation has stayed high since late 2009, always flirting with double digits. Now, at last, it seems to be heading down. In July wholesale prices rose by 6.9%; “core” inflation, which excludes food, among other things, has been 5-6% for several months. The Reserve Bank of India (RBI) targets wholesale inflation of about 5%.

India’s industrialists and some politicians are screaming for lower interest rates. Growth has fallen to about 5% and private investment has dried up. Having engineered a slump to satisfy its rigid obsession with low inflation, they argue, the RBI can at last slash rates to kick-start growth.

Will the RBI oblige? It is still worried about inflation. Food prices may rise because of a poor monsoon. Other one-off shocks are likely. Oil prices are creeping up. The figures do not yet reflect widespread increases in electricity tariffs. Suppressed inflation, thanks to state subsidies of fuel, is running at two or three percentage points. If the government is to repair its dodgy finances this year it will have to cut those subsidies, pushing prices up. Lastly, the RBI doubts that interest rates, which in real terms are not that high, explain the slump in investment. Bad governance and a lack of reforms do. Much lower rates might end up resurrecting inflation, but not growth.

The stage is set for a confrontation. The ruling Congress-led coalition, unable or unwilling to pass reforms and facing an election in 2014, wants looser monetary policy. Under the previous finance minister, Pranab Mukherjee, its outbursts came uncomfortably close to political interference. The new finance minister, Palaniappan Chidambaram, has already asked state-owned banks to cut rates on consumer loans to revive demand.

Since the mid-1990s the RBI’s independence has been accepted by the political class. Its real guarantor, though, is a sense that sound money is what most Indians want, even at the price of temporarily lower growth. But lately there has been little anguish about inflation. One theory is that the public’s dislike of high prices is a myth—some studies suggest high growth, not low inflation, wins votes. In a survey after the 2009 elections voters put inflation as only a middle-ranking concern. Fast-rising rural wages may also have insulated the poor.

Another theory is that the decline of India’s Marxist parties, the rise of regional politicians and a vocal anti-corruption movement all mean that public anger over high prices is somehow being deflected. Whatever the explanation, for the RBI the lack of public outcry is a worry. It’s a lot easier to be independent if you have 1.2 billion people on your side.

India’s fight against high prices

The remark appeared innocuous, reasonable even, but for a country with few respected public institutions, it was unnerving. If India’s bond market were not so tightly controlled it might have created a minor scare. At a public event on December 2nd the governor of the Reserve Bank of India (RBI), Duvvuri Subbarao, was asked by his predecessor if it would relax its medium-term goal of 4-5% inflation. This is not a strict target of the kind some Western central banks try to stick to. But it is an ambition that the RBI has long held.

Mr Subbarao replied: “I am not saying that we will definitely change the number, but we will certainly revisit our strategy.” Only last month the RBI published a paper saying the opposite. In the battle against inflation, abandoning the goal would be “nothing short of admitting defeat,” says Rajeev Malik of CLSA, a broker.

The cock-up theory is that Mr Subbarao mis-spoke. But the RBI has not backed away from his remarks, which come at a difficult time for India. Since 2008 inflation has remained high, despite the RBI’s repeated tightening. GDP growth slowed to an annual 5.3% in September; investment by firms is low; and the fear of bad debts stalks some industrialists and their banks, which want relief.

Commodity-price shocks help explain stubbornly high inflation. But the government is also to blame, thanks to its lack of reforms and high borrowing. The new finance minister announced a mini-package of economic measures in September with much fanfare, and has made it clear he now wants the RBI to cut interest rates. With a general election due by mid-2014 politicians are desperate for faster growth.

The idea that the RBI might yield to such political pressure is not so far-fetched. It is not statutorily independent. Its bigwigs are often hired from the government and return to it after their stints: the prime minister used to be governor. The one outsider among the RBI’s top brass, Subir Gokarn, who has lots of fans among investors but has been critical of the government, is yet to have his tenure as deputy governor renewed. It expires at the end of the year. The RBI also has contradictory mandates, like many central banks nowadays. As well as its monetary duties, it also acts as the government’s banker and guards financial stability. In the name of these latter two goals it forces banks to buy government bonds and purchases some itself, depressing yields. That arguably makes it complicit in the public-sector borrowing binge that fuels inflation.

Critics argue that the RBI has already been cutting by stealth, using liquidity-management tools and verbal guidance to make sure market interest rates have dropped even as the policy rate has stayed unchanged since March. Ditching the inflation target would, by this account, just be an admission that it never had the stomach to enforce it in the first place.

The RBI would put things differently. Although its empirical work has previously suggested that 5.5% is the maximum healthy level of inflation, lately something has changed. Despite a sharp economic slowdown prices have kept on rising. A big chunk of demand seems to be insensitive to what the RBI does. The government borrows regardless. Rural consumers, who are doing well and are often outside the formal financial system, are shifting to richer diets, pushing up food prices.

That leaves the RBI with a lousy option, to temper demand by disproportionately hitting the narrow range of activity that is sensitive to interest rates, in particular private-sector investment. But that means fewer new factories and roads, which damages India’s long-term potential. Clearly, it would be good if the government got its act together. Assuming it does not, though, the lesser of two evils might be higher prices and a perkier private sector.

Yet there is no guarantee investment would revive: the main problems are graft and red tape. Real interest rates are already looser than during the boom of 2003-08. Higher inflation might prompt a wage spiral. The public’s inflation expectations are uncomfortably high, at 13%, one reason why they buy so much imported gold, hurting the balance of payments. And without the RBI providing discipline of sorts, politicians might behave even more recklessly. India has many public institutions run on the basis of deferring difficult decisions for short-term gains. The RBI should think hard before joining them.

 

a volatile trade today at dalal street

• The Sensex closed at 19122, up 31 points from its previous close, and Nifty shut shop at 5741, up 12 points.
• The BSE Sensex eked out a 0.2 percent gain on Tuesday after falling for two consecutive sessions, but trading was volatile and the near-term outlook seemed subdued as investors shunned risk after rating agency Standard & Poor’s lowered its U.S. credit outlook to negative.
• State Bank of India, the country’s largest lender, said on Tuesday it will raise its benchmark lending rate, or base rate, by 25 basis points to 8.5 percent per annum with effect from April 25.
• The Indian government on Tuesday forecast normal rains for the 2011 monsoon, strengthening the prospect for a good farm output that could help bring relief to Asia’s third-largest economy in its battle with high food prices.
• Harley-Davidson Inc reported a wider quarterly profit on Tuesday on higher income from the company’s financial services division and a 3.5 percent increase in sales of new motorcycles.
• The government is risking losing control of inflation, leaving the Reserve Bank of India (RBI) with few tools other than the blunt instrument of more aggressive interest rate increases even as growth momentum slows.
• Falling gas output and a rising subsidy burden are expected to weigh on the respective outlooks of energy major Reliance Industries and explorer Oil and Natural Gas Corp, taking the shine off their likely strong fourth-quarter earnings.
• The Indian rupee pulled back from a 2-1/2 week low touched earlier in the session due some dollar selling at higher levels.
• A German government adviser said on Tuesday that a restructuring of Greek debt was inevitable, raising pressure on Athens to seek a solution to the debt woes that are shaking investor confidence in the euro zone.
• India’s annual headline inflation in April could ease below 8 percent and 2011/12 economic growth should range between 8.75 and 9.25 percent, the chief economic adviser to the finance ministry said on Tuesday.
• Falling gas output and a rising subsidy burden are expected to weigh on the respective outlooks of energy major Reliance Industries and explorer Oil and Natural Gas Corp, taking the shine off their likely strong fourth-quarter earnings.
• A renewed rise in Spanish debt yields is bad news for the euro zone, since it shows Spain is still failing to set itself apart from the zone’s weakest states in the eyes of the markets.
• Some of the United States’ biggest creditors moved to shore up confidence in its sovereign debt on Tuesday after Standard & Poor’s threatened to cut its credit rating on the world’s top economy, touching a nerve among big holders of Treasuries.
• Costly oil could place a major strain on consumer countries with fragile economies, OPEC ministers said on Monday, in their clearest statements yet that they believe fuel demand has shrunk.
• India, which has allowed exports of 500,000 tonnes of sugar following a bumper crop, has asked mills to register starting Tuesday, a source in the food ministry said.
• Foreign direct investment flowing into China rose 29.4 percent to $30.3 billion in the first three months of the year, data showed on Tuesday, as the country’s booming services sector pulled in more funds.
• China will tightly regulate land supply to boost affordable housing and to clamp down harder on illegal land use this year, the Ministry of Land and Resources said on Tuesday, as it seeks to contain housing inflation.
• India’s current account deficit for the last fiscal year that ended in March 2011 is expected to be less than 3 percent, Trade Secretary Rahul Khullar told reporters on Tuesday.