Problem is Rahul-flation: Why RBI is failing with rate hikes

Discussion in 'Economy & Infrastructure' started by Vyom, Sep 19, 2011.

  1. Vyom

    Vyom Seeker Elite Member

    Joined:
    Dec 23, 2009
    Messages:
    1,041
    Likes Received:
    328
    Why is inflation refusing to lie down and play dead when the Reserve Bank has trained all its guns on it? Why is a government headed by an economist, and who is further surrounded by even more first-rate economists (Kaushik Basu, C Rangarajan, and Montek Singh Ahluwalia), not able to do anything more than wring its hands in despair about inflation?

    The answer, in one line, is simple. India’s inflation is driven by populist spending and wrong economic choices – both dictated by the need to create an entitlement-based economy, presumably to help elect Rahul Gandhi as the next prime minister in 2014.

    In short, what we are seeing now is Rahul-flation, not conventional inflation.

    Two interviews last week, one with Indian Oil Chairman Ranbir Singh Butola, and another with the Finance Ministry’s Chief Economic Advisor Kaushik Basu, sum up the economic mess created by the UPA government in pursuit of its political goals.

    Basu, who made the headlines recently by advising the Reserve Bank of India (RBI) to think “out-of-the-box” and avoid raising interest rates, has confessed that the government does not have “clear answers” to the problem of inflation and growth. He told Karan Thapar on CNN-IBN: “I agree with you that we don’t have a clear answer, but…it is important to understand that there isn’t a clear answer anywhere in the world; emerging economies are all inflating, it’s a new world we are encountering.” (See full interview)

    Thanks, Mr Basu. If you don’t have “clear answers”, why go around advising the RBI Governor on what he should do? But at least we have some honesty in Basu’s answers. He now says that inflation will “remain choppy and difficult till about December. The month of December should see a distinct drop in inflation.”

    So, when will we see more reasonable 4-5 percent rates? Basu’s reply: “Not till the middle of 2012, unfortunately.” That’s eight or nine months away.

    The jury is, of course, out on whether even this forecast will hold in the context of the fact that most fuel price hikes are still on hold. The recent hike in petrol prices – purely a rich man’s fuel – suggests that the more important revisions in cooking gas, diesel and kerosene will need tough political battles – for which the UPA has shown no stomach so far. Moreover, coal prices and power tariffs are also due for a hike, which will start feeding through to the economy over the next eight months.

    This brings us to the counter-argument: when inflation is far from tamed, should we be raising energy prices?

    This is where we need to look at what the Indian Oil Chairman Butola has to say. He told The Times of India that it would be wrong to look at the impact of petrol and diesel price hikes as inflationary as the alternative will not lead to less inflation (A Rs 3 raise in petrol impacts the wholesale prices index by 0.07 percent while a similar hike in diesel impacts it by 0.42 percent). You get it either way: cost-push inflation or demand pull.

    Let’s hear Butola on this: “It will be a fallacy to look at only these numbers, given the fact that we…import more than 75 percent of the crude we consume. If we do not pass the impact of high global prices to consumers, worrying that it will burden them, we will not be conveying the correct picture. The economy has to ultimately bear the burden of losses on fuels. Since a large part of such losses is compensated by the government, consumers will any way be affected indirectly by high fiscal deficit and resultant inflationary impacts. That (cost) will have to be borne by all.”

    Now contrast this with what Basu is saying in his interview. He wants interest rates cut to foster growth. He also wants to keep the fiscal deficit – the gap between government revenues and expenses — close to the budget-promised 4.6 percent. About the fiscal deficit he said: “The fiscal targets will be difficult, but …are still very achievable…the target that we’ve set for ourselves, 4.6 per cent, we should get pretty close to that. ..I can’t give you a number, but we won’t reach 5 percent.”

    Now, this assurance comes after the first quarter fiscal deficit was put at 7.8 percent and inflation is close to double-digits, and fuel prices have not been passed on to the consumer for fear of stoking inflation.

    This brings us to the crux of the dilemma facing the government. It really has a choice between two kinds of inflation: cost-push versus demand pull. Raising fuel prices will push up costs, and raise short-term inflation, but cutting rates will boost demand, and will be inflationary over a longer-period, especially when the fiscal deficit is soaring because of fuel price subsidies. Even after the hikes in June and now, oil companies will lose around Rs 1,20,000 crore this year – and this money will have to come from the budget and add to the fiscal deficit.

    This is the fundamental dilemma the UPA has faced for the past few years, and it has consistently flunked the economics test of political policies. It is unlikely that Manmohan Singh or P Chidambaram or Pranab Mukherjee did not grasp the need for sound fuel pricing or limiting subsidies. The only explanation can be that economic policy is being driven by the economically-illiterate political caucus around Sonia and Rahul Gandhi.

    In fact, all the policies of the UPA have focused on entitlements and the redistribution of wealth – from the farm loan waivers to subsidised fuel to the (forthcoming) Food Security Bill to the Right to Education Act and the Land Acquisition and Mining Bills. These are going to impact both costs and demand. Inflation is thus driven, and will continue to be driven, from both ends – higher costs and higher demand.

    Ask yourself a basic question: how can the hike in general rural wages through NREGA not raise the cost of farming and food? How can the Right to Education not raise the cost of schooling when fresh educational capacity is not being created fast enough? How can a Bill that seeks to up the cost of land acquisition to four times the market price not raise the cost of housing or infrastructure or manufactured products? How can the Mining Bill – which seeks to overcompensate tribals and others – and the ban on mining in some areas not raise the cost of metals and ores? How can a Food Security Bill, which will mandate the government to procure almost all the available grain in any year, and then import some, not raise the market prices of food items?

    Kaushik Basu is right when he excoriates the Reserve Bank for raising interest rates when the results have been less than expected. But it is not the Reserve Bank’s fault. The problem is that the government is simply not doing its bit. In fact, it is fuelling inflation through its stupid pork-barrel schemes.

    How can raising interest rates bring down inflation when all of the government’s policies are inflationary? When the policies of the government are driven by the need to get Rahul Gandhi elected through populist giveaways to an imagined rural and tribal audience, how can interest rate cuts alone work wonders?

    The Reserve Bank’s policies will work only by dramatically slowing down growth – which is what Basu is afraid of, but is unwilling to tell his finance ministry bosses about.

    The truth is short-term inflation – up to the middle of 2012, according to Basu – is a certainty. But long-term inflation can be fixed if the government gets its supply-side policies right. These have to focus entirely on increasing supplies of goods and services – from foodgrain to land to social services like education and health. These could include:

    Reworking the Land Acquisition Bill to ensure transparency and fair prices, but not mandating a huge increase in cost for housing and manufacturing. Mining and environmental laws need to be transparent rather than just obstructionist.

    Reworking labour laws, which will allow industry to recruit more. Without the right to fire (without prejudicing the worker’s right to justice) no one will hire.

    Restricting the Food Security coverage to households below the poverty line. Once the Unique Identity (UID) scheme becomes universal, food security should become a cash transfer scheme for the very poor. Moving foodgrain from Punjab to Kerala and from Andhra to Assam is hugely expensive and inflationary.

    Raising agricultural productivity, including horticultural and dairy and poultry production. Today, food inflation is not driven by rice, wheat and coarse grains, but by higher protein-based consumption of fruits, vegetables, dairy products, poultry and meat.

    Opening up the education and retail sectors to foreign players. The former will improve the availability of quality higher education, freeing the government to use its resources for improving quality and quality at the primary and secondary schooling levels. Opening up the retail sector will improve efficiencies in farm-to-fork logistics and create urban jobs in the supply chain and the new Wal-Marts of India.

    The curb on demand need not come wholly from rate hikes. Instead, it can happen through deregulation of fuel prices – mainly diesel, coal and power tariffs. If the government wants to subsidise cooking gas and kerosene, the subsidies should be full reflected in the budget, and not be left to ONGC and oil bonds. There is a case for restricting even these subsidies to the poor – as identified by the UID project.

    A deregulated cost-push inflation is economically more efficient than a fiscal-deficit driven demand boost since rising fuel prices force consumers to rationalise the use of scarce energy sources, while an inflation driven by fiscal deficits (government borrowing and printing of money to make ends meet) creates broader inflation.

    India’s inflation has become structural because of the UPA’s flawed spending policies, and this fact is evident from a recent study by Gangadhar Darbha and Urjit Parel for the Brookings Institution. A summarised version of the study, published in Business Standard, says that the current inflation is not driven by transitional factors like a failed monsoon on higher imported energy prices.

    “We find that, contrary to the general belief, a significant part of core sector inflation (that is, non-food and non-energy) since 2004-05 is driven by increasingly persistent aggregate or common factors. It would seem that the lax macro-economic policy environment, more than food and energy shocks, seems to have stoked generalised inflationary expectations, thereby making the overall inflation process highly inertial.”

    The bad news is that it can only get worse. Darbha and Patel conclude: “As against the hope of policy-makers, overall inflation may not moderate even if the food and energy price shocks subside. The more broadbased inflation is, the less amenable it is to amelioration with minimal output losses. It may have dawned somewhat late on the Reserve Bank of India that the underlying drivers were getting stubborn, forcing it to undertake robust hikes in policy interest rates of late, that would not have been necessary if early action had been taken.”

    In short, Darbha and Patel are saying that the RBI’s fault was that it did not raise interest rates soon enough, not that it cannot work. The real problem is the “lax macro-economic environment” created by UPA’s populist policies.

    Mr Basu, it is Sonia and Manmohan Singh who have to be tutored on “out-of-the-box” thinking to bring down inflation, not Duvvuri Subbarao. Subbarao’s problem is that he listened too much to North Block, not too little, on rates.

    The immediate choice is between cost-push inflation and fiscal imprudence through higher subsidisation, especially of fuels. Cost-push is the lesser of the two evils.

    We have a choice between Rahul-flation and sensible economics.

    Problem is Rahul-flation: Why RBI is failing with rate hikes
     
  2.  
  3. Phenom

    Phenom Regular Member

    Joined:
    Mar 6, 2010
    Messages:
    878
    Likes Received:
    401
    Nice article,

    The effect NREGA has had on increasing the wages in rural area is immense. The worst part is NREGA has increased the cost without increasing the efficiency. Now a days finding affordable labour in rural area is one of the biggest challenge for any farmer. And the increase in cost of production are now being passed on to the customers.
     
  4. sob

    sob Moderator Moderator

    Joined:
    May 4, 2009
    Messages:
    6,359
    Likes Received:
    3,661
    Location:
    New Delhi
    With these schemes we have witnessed almost zero growth in employement in the last 7 years, while the GDP has been growing at almost 8%+. This is an achievement of this Govt. The main reason is that almost 27 million people have been covered under the Govt. Dole.

     
  5. Vyom

    Vyom Seeker Elite Member

    Joined:
    Dec 23, 2009
    Messages:
    1,041
    Likes Received:
    328
    Unfortunately though this is definitely going to help the Congress in the general elections. Populist scheme are such hukum ka ikka. Uninformed people will fall for the bait.
     
  6. Param

    Param Senior Member Senior Member

    Joined:
    Jun 9, 2010
    Messages:
    2,808
    Likes Received:
    647
    Location:
    TN
    This is was happens when morons are groomed to head a country. The country pays a price for the retards.
     
  7. ejazr

    ejazr Stars and Ambassadors Stars and Ambassadors

    Joined:
    Oct 8, 2009
    Messages:
    4,518
    Likes Received:
    1,378
    Location:
    Hyderabad and Sydney
    This is certainly true. The RBI bumping up interest rates is choking growth without doing anything for inflation. It was just unnecessary but they keep using this blunt instrument. On the other hand GoI is going on a spree to introduce populist measures like Right to Food, Right to Education e.t.c. which will further put inflationary pressures.
    While moves like allowing retailers to enter the Indian market are still on the shelve and unfortunately even BJP opposing the move might not even come through.
     
  8. KS

    KS Bye bye DFI Veteran Member

    Joined:
    Aug 3, 2010
    Messages:
    8,008
    Likes Received:
    5,718
    Location:
    irrelevant
    Is it just me who thinks whats up with this sister concern of known bjp-baiters IBN - First Post - being much more pro-BJP ...any one noticed ?
     
  9. IndianPoliticalForum

    IndianPoliticalForum Tihar Jail Banned

    Joined:
    Sep 16, 2011
    Messages:
    11
    Likes Received:
    1
    Rahulflation

    Thanks to Lazy_Geek aka Bangalorean for this post on IPF.


    Yes, that's right - Rahulflation is what India is currently suffering from, not inflation. From the article:

    The answer, in one line, is simple. India’s inflation is driven by populist spending and wrong economic choices – both dictated by the need to create an entitlement-based economy, presumably to help elect Rahul Gandhi as the next prime minister in 2014.


    Normally, I don't personally support either the BJP or the Congress - I vote for the candidate, and not for the party. All the same the implementation of NREGA is a topic on which I have had huge arguments with congress supporters on various forums.

    NREGA funds are being wasted, and creating a culture of entitlement and dole - all for the purpose of vote gain. Spending needs to be focused - towards building assets. Afforestation, canals, drainage networks, village roads, and such stuff. Train NREGA recepients to move up the ladder by acquiring skills like welding, carpentry, and so on, instead of remaining beasts of burden.

    I admit that in rare cases, NREGA spending has been useful and has gone into creating actual useful assets. This, however, has been the exception rather than the norm. This culture of digging holes and filling it back in, is causing immense harm to the Indian economy in many ways. And there was a Congress supporter on the other forum who kept insisting that it is perfectly all right even if people are made to dig holes and fill them in!!

    Rahulflation is the problem. We've slashed our growth by at least a percentage point because of these populist and vote-greedy policies.

    http://www.firstpost.com/business/p...why-rbi-is-failing-with-rate-hikes-86895.html
     

Share This Page