Wednesday, January 16, 2013

Indian Guinea Pigs: Starve Them To Control Inflation
Yes, this seems to be the logic of the Governor of RBI, to keep on harping on inflation, the every other day, to justify his stand on a status--quo on repo rate cut. He has no thought of how the loans are getting nonviable for companies, who are not able to pay them. 
Now, many of the policies of inflation control that we nowadays use routinely are direct outcomes of the research and contemplation of economists of earlier years. However, the lamenting point is that, off-late, these are applied by every body, starting from the eminent economists to chartists to men on the streets, to even "Paanwala" ("Array sahab RBI bechara,  bhi kya kare, Kambhakt inflation niche utarne ka naam bhi nahi le raha hai") or may be my "Rickshawala" ("Sahab Mehengai ki wajeh se hi sab problem  hai. Ekbar unko niche aane do, hum sab market se khub kamayenge. Mera bhi Demat Account  hai na!! Kya saab aap bhi sab cheez ko mazak samajte ho"....LOL) like a steroids---many a times without understanding that all these policies  have limited applicability, in a given circumstance, as the price of a commodity is determined by a string of complex events, whose co-efficients change every second. Moreover like, specific plants and animals grow well in specific environments, in economics too there are peculiarities, associated with particular regions and hence economic parameters vary for nations at different stages of development. It is therefore imperative to do fundamental research on inflation, before applying, stereotyped policies, especially when the guinea pig is India, an emerging economy in Asia. 
Now, drilling the history of inflation a bit we find that it jumped to trillion percent, in Hungary in 1946 and Germany in 1923, but still the countries survived. In independent India highest inflation happened in September 1974, when we had tasted it to be 33.3%. One of the worst inflationary trend was seen from November 1973 to December 1974, when inflation never dropped below 20% and was above 30% for four consecutive months starting June 1974. Indian survived and Indians are making a name in every field of interest. 
But alas!! Now we Indians become too much finicky when the WPI inflation is only around 7--7.5%. This is because most our vocal younger generation have not seen hyper--inflation or galloping inflation and are more governed by some fixed notions, without going deep into the subject. Today, we have become more or less like ATM machines---just press the button and the result should come. Yes, even our modern housewives I heard, like husbands who are like ATM machines. 
Now coming back  to inflation again, I would like to say that we are nowhere near hyperinflation—usually described as inflation over 50% per month (Cagan, 1956). The world’s steepest inflations occurred in Europe, once around 1923 and again around 1946.
Now  switching back to India again, we must take into notice that a major portion in CPI, consists of the food items. Or food articles have a higher weight in the consumer price index (CPI, base 2010) than the wholesale price index (WPI, base 2004-05). Consumer price food inflation rose to 13.04 % in December from 11.81 % in the previous month. Food inflation was in double digits in the WPI as well at 11.16 %, compared to 8.5 % in the previous month. Hence, this time too, RBI's policy of keeping higher interest rate has failed to damp the prices. However, I feel we will not be able to justify that if the rates were made low, then suddenly all Indians would have started eating more and become glutton, giving rise to more food inflation; which many of our theoretical economists would like us to believe. The behavioural pattern of any person, does not change overnight. 
Now, it is obvious that, CPI will not come down too much unless there is a downward spiral in the food prices, which means the demand for food has to come down. Is it possible in the real sense, without starving the people of India? How can people start eating less? Is the RBI,  thinking of starving the Indians? What is this policy then aiming at? I have written last month that CPI will increase, on my blog, if you can remember----because food falls under inelastic demand and the same thing happened.  
On the other hand when WPI is coming down, that does not mean CPI should also come down, because both the indices have different allocations for food articles. So, what can we conclude? 
Does that mean, that for only food inflation, the whole of the Indian economy including the manufacturing, which is one of the pillars of India Shinning Story, should collapse? If there is a problem in one segment, then does that mean that the whole economy should suffer 
What is this logic?
Besides, we must always remember that inflation management is a very tricky job and standard definitions cannot be applied, in every case. A close look of the Brazilian economy, since 1962, shows that it did not have a single year where inflation was in single digits from 1962 to 1997. There were only a couple of years (1973 and 1974) when inflation was below 20%. The worrisome period was 1988 to 1994. Prices were rising on average close to 2000% per annum during this time. Now taking Brazil's case into context, we find that when inflation was below ten percent, there is little correlation between the rate of inflation and the growth rate. But when it rose to higher levels, the growth started to taper down. However, there are many economies where we would find that they had a strong growth sustaining, even when they had inflations over 10%. 
So, how do we explain this dichotomy? Besides, most of the governors of the RBI, had earlier stressed on giving more importance to core (manufactured items sans food products) inflation, which was down to a 33-month low, to 4.19 % in December from 4.49 % in November. Interestingly, over the past two months, core inflation remained below its long-term (seven years) average of 4.7 %, an analysis by YES Bank showed. So, when our RBI Governor belches out irresponsible market sensitive statements in Economic Times, does he not take this part of inflation into consideration; for a Repo rate cut on 29 th January, 2013....??!! 
Hence, I would like to point out that standard medicines sometimes is not applicable in all cases. When the parameters changes, the disease can also show other symptoms, rather than normal ones. Therefore, while devising a panacea for inflation, one needs to be very cautious, because a higher dose could prove to be near fatal for any economy, as such steroids or forced policy interventions invariably comes with dangerous side-effects.
Is Indian ready to bear more such blows? Let the RBI Governor decide.