The Indian government’s outgoing chief economic adviser Kaushik Basu has said inflation is a “partially-understood discipline”. I bet he is a bit generous in his assessment. The ideal way of putting it could have been inflation in India is a “hardly understood” or a “much misunderstood” discipline. In the past three years, many—including Basu himself and India’s central bank—have gone wrong in their projections of the inflation trajectory. Now, the Reserve Bank of India (RBI) seems to be opening a new front on the inflation debate—what inflation trend should it look for to formulate monetary policy? Wholesale? Retail? Or, the so-called core, or non-food and non-oil, inflation? Which inflation index should RBI target?
RBI governor D Subbarao.
To be sure, RBI governor D. Subbarao has all along positioned himself as an inflation fighter, and not as an inflation targeter; but that doesn’t iron out the complexities that surround the inflation debate. In February this year, at an international research conference of RBI, Subbarao had said that the central bank can’t be an inflation targeter, or a core inflation targeter, as that will not serve the best interests of the macroeconomic management of the country. At the same time, he had mentioned that the government had never been insensitive to inflation, and inflation management usually takes precedence over growth concerns. Before that, in August 2010, while delivering the 10th C.D. Deshmukh Memorial Lecture, Subbarao had said RBI cannot be, and, indeed, should not be, a pure inflation targeter. “In an emerging economy like ours, it is not practical for the central bank to focus exclusively on inflation, oblivious of the larger development context. The Reserve Bank needs to balance between growth, price stability and financial stability.”
“Our headline inflation index is WPI (Wholesale Price Index) and that does not, by definition, reflect the consumer price situation,” he said. “Getting a single representative inflation rate for a large economy with 1.2 billion people, fragmented markets and a diverse geography is a formidable challenge.”
Nobody says it’s a cakewalk; but it’s frustrating to see on such a critical issue, policymakers continue talking in different languages, pointing to different directions and creating confusion in the market. Early this month, C. Rangarajan, former RBI governor and economic adviser to Prime Minister Manmohan Singh, said falling core inflation will give room to RBI to cut its key rates. “I believe if the inflation rate, particularly non-food manufacturing inflation, shows signs of decline, there will be scope for RBI to adopt an easier stance,” Rangarajan said on the sidelines of an event in Delhi.
If indeed this is the case, why did Subbarao last week take pains to explain why core inflation should not be the sole focus of RBI? Core inflation excludes food and fuel, which constitute 50% and 15%, respectively, to the consumption basket. “Can a measure of inflation that excludes them be called core?” Subbarao asked. The inflation in fuel and certain protein food items has been persistent in the past three years. “Can a persistent component be excluded from the core measure?” Subbarao asked. RBI insiders say the central bank these days is increasingly focusing on retail inflation while making policies. Which is why the possibility of a rate cut is not too bright at this moment.
Retail or Consumer Price Inflation (CPI) in June eased marginally but remained in double digits because of high food prices. The annual inflation based on all-India general CPI (combined) for June stood at 10.02%, marginally lower from 10.36% for May. Retail inflation rates for rural and urban areas for June were 9.74% and 10.44%, respectively. These are provisional figures. The comparable final figures for rural and urban areas for May were 9.57% and 11.52%, respectively.
Inflation, as measured by WPI, slowed to its lowest level in five months in June—7.25%—following a drop in the prices of some fuel items. Wholesale prices rose 7.55% in May. The core inflation remained unchanged at 4.8% in June.
Subbarao made two critical statements from two different platforms last week. First, he said the inflation threshold is 5% for India and right now “we are way above that threshold”, while launching a book of essays by former RBI governor, the late I.G. Patel. The next day, speaking at the Statistics Day Conference in RBI’s Mint Road headquarters, Mumbai, he said core inflation might not be a true indicator of price movement in Indian conditions.
He is in favour of moving towards developing and using a Producer Price Index (PPI) to gauge inflation more accurately. WPI does not capture the price movement of services and is a hybrid of consumer and producer price quotes. Sellers’ and purchasers’ prices differ due to government subsidies, sales and excise taxes, and distribution costs. “For these reasons, it is desirable that we move towards developing a PPI that measures the average change over time in the sale prices of domestic goods and services,” Subbarao said.
Nobody can find fault with the governor’s argument. But till such time PPI is developed, both the government and the central bank need to figure out how to bottle the inflation genie. We can continue to analyse the different inflation indicators and dissect the different components of inflation till the cows come home; but that will not in any way help the corporate borrowers, who want the cost of money to come down, to make investments that will fuel economic growth, and the savers who want higher returns on their savings to protect the value of money from being eroded.