The Reserve Bank of India (RBI) recently concluded its platinum jubilee celebrations. Over the years, it has acquired a deservedly solid reputation— among knowledgeable observers, that is—for prudent macroeconomic management in a country that is addicted to unaccountable and persistently large fiscal deficits. It has been rightly hailed as an intellectual leader among global central banks for its recognition of the dangers of unsustainable credit booms and securitization. Indians should be proud of this institution. But, fair or not, institutions in emerging countries have to earn their reputation continually and its next challenge is already upon RBI—and that is the scourge of inflation. Inflation measured by the Consumer Price Index (CPI) for industrial workers stood at 16.2% in January. India’s CPI may have many limitations but overstatement of inflation is not one of them.
Writing in his regular column in the Mumbai Mirror in February, Ajit Ranade, economic adviser to the Aditya Birla Group, conceded that food inflation has never been this high and persistently so. Now, for sheer lack of any other empirically verified alternative explanation, India’s inflation problem appears to be a case of too much demand. Aspiring doctoral research candidates in economics should examine whether the emergence of a strong government-corporate nexus in recent years has anything to do with the higher inflation rate. For now, we will stick to more prosaic explanations. Ranade wrote that the rural employment guarantee programmes have put a lot of purchasing power in the hands of rural population, and hence, demand for food has shot up. That, other things being equal, pushes up prices.
In a special report on inflation published in March, Jahangir Aziz and Gunjan Gulati of JPMorgan endorse this view and also point that CPI inflation is higher than inflation at the wholesale level due to the importance it gives to services sectors such as medical, education and housing. They think that until reforms raise productivity in the agriculture and services sectors, inflation would prove to be sticky at a medium-term average of around 6-7% and warn that any attempt on the part of RBI to bring it down to 5% might be bad for growth. That is open for debate, if not disagreement.
It is clear that demand strength has returned to the Indian economy. Airlines are contemplating raising prices. Car prices are rising partly because of the excise duty hike announced in the Budget and, perhaps, more due to robust demand. Automobile sales growth in 2010-11 would be “only” in low double digits and that too because of the base effect from 2009-10, which recorded a 25% growth rate.
The crisis of 2008-09 hurt India, in the sense that it suppressed debate on the flawed approach to growth the United Progressive Alliance (UPA) government had followed in its first outing. Even learned commentators found fault with RBI for tightening monetary policy in 2007. They thought that India had miraculously achieved a combination of high growth and low inflation and that all that RBI was doing was to rain on the parade. But recent experience with inflation (it is not just about food, stupid) has proved RBI right and them wrong.
UPA-II is pursuing the same macroeconomic framework and goals as that of UPA-I—high growth through government spending rather than through unshackling economic activity via liberalization. This public sector-led growth is inflationary, unsustainable and corrosive through its encouragement of corruption. Unfortunately, it is difficult to put a precise time frame on this, since economic consequences arrive with uncertain and variable lags. Accountability in governance is as difficult to achieve as it is in investment banking. Further, the buck for economic decisions stops at the wrong place in the current UPA dispensation. Finally, the absence of a credible and intellectually effective opposition in the country has reduced policymaking to its lowest common intelligence.
In such a situation, RBI has very little choice but to curtail demand. It is too much behind the curve and is at the risk of losing its hard-won credibility. The central bank has to be a killjoy for an economy on a sugar-high now. Monetary policy tightening in April has to be considerable.
Investors have been chasing Indian assets in recent years, except during the crisis months in 2008-09. Even then, foreign direct investment inflows continued and look set to have broken into a permanently higher level. That should not complicate the central bank’s thinking. If higher interest rates trigger more short-term flows, the central bank should not hesitate to use capital control measures.
India is wrong to compete in the global economic growth sweepstakes. That has pushed this government into pursuing unsustainable demand-led growth. RBI starts off with an enormous advantage in its policy competence. The inflation challenge is an opportunity to consolidate its position as the leader in monetary policy globally. There can be no fitting way to celebrate 75 years of mostly distinguished service to India.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org