Policy Pass-through failure pushes inflation in India

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According to Milton Friedman Inflation is taxation without legislation.

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The Reserve Bank of India's (RBI) statutory mandate is to secure monetary stability in India. The Government of India amended RBI Act in 2015. The act prescribes maintenance of consumer price index (CPI) inflation within the corridor of 4 percent plus or minus 2 percent. If the CPI or consumer inflation increases beyond 6 percent, RBI fails statutorily. Fortunately for RBI, India is used to condone systemic statutory failures with a series of laboured rationalizations. Consumers of India are enduring the consequences of RBI’s statutory failure by paying for the price rise continuously though out the year. Whatever lip may say, Government is innately happy that inflation increase input and output costs and GST collection witnesses a buoyancy. Instead of being apologetic, Government takes pride in such higher GST collection even as people suffer.

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Inflation raises price. India follows Consumer Price Index (CPI) and Wholesale Price Index (WPI). While WPI hovers around 15 percent, CPI hovers around 7 percent. World splits CPI into core inflation and headline inflation. Food and energy are most price volatile. When their prices are excluded to determine inflation index of other goods and services we get core inflation. In well managed countries core inflation remains near zero for decades. Headline inflation includes food and energy prices which is mostly equivalent of CPI in India. In India core inflation itself is more than 6 percent indicating continued policy failure in managing finances or more focused inflation. People are used to price rise and offer opportunity for political picnic in hills of power.

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RBI has a plethora of tools for controlling excess liquidity. Monetary Policy Committee (MPC) was constituted by Government to primarily set sound RBI policy for liquidity management so that people are not distressed. Excess liquidity has been Rs 3.8 lakh crore in June-July 2022. Quite clearly, the RBI has not been able to deliver on its inflation mandate. The RBI decided to hike its short-term funds lending rate (repo rate) by 50 basis points on 5 August. It continues to remain accommodative, though its official stance has been ‘withdrawal of accommodation’ since the last policy meeting. Scientifically RBI has to be prudent in increasing repo rate by another 0.75 points, which they will do in any case failing which they will fail themselves in their primary duty of easing prices by liquidity management.

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The RBI's role in inflation management is on the demand side, which it can manage by adjusting money and credit supply. Effectiveness of any central bank is assessed by pass through behaviour of its policies and policy stances. By pass-though is meant whatever central bank intends to happen due to its policies should happen in the field immediately. RBI is showing a poor record of pass-through behaviour of its policies. Its policies rarely get absorbed in the constituencies before six to eight months. When RBI wanted to control credit growth now, it keeps increasing, Credit growth exceeded 8 percent in January 2022 which was desirable post pandemic liquidity infusion but steadily went up thereafter, 11 percent in April, 12 percent in May, 13 percent in June, and 14 percent in July. No effect of Repo increase on credit growth when Repo is increased to arrest credit growth.

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Inflation is the result of many factors most important are changes in the real economy, governmental policy actions, and global inflation. There is cost pull inflation and demand push inflation. Prices rise as “Cost-Push inflation,” or inflation that begins when rising costs result in increased prices, and “Demand-Pull inflation,” or when people’s ability to spend rises more rapidly than the availability of goods and services. Inflation is likely to come down in coming months when these elements change. The RBI policy will not, however, contribute to that. The RBI policy rate increase will likely remain more of a formality not policy to ensure results.

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India continues to be in large deficit in current account, which is quite likely to see a deficit in excess of $100 billion in 2022-23. The Rupee is internationally exchanged with the dollar through which Rupee exhibits its external value. RBI only impacts external value of Rupee by indirect impact of its policies and operations. Advanced economies are showing signs of sliding into recession or serious slowdown. India will get relief on commodity prices but exports will be lost due to such recession elsewhere while India is inflexible in imports. This will annul any improvement of balance of payment. Government and RBI must induce policies to improve capital account flows and NRI deposits of Indian diaspora. But not enough is being done now resulting in exchange rate issues. In last twelve months India saw substantial outflows of market investments. All three non-commoditized receipts are sinking in areas like government debt, external commercial borrowings and NRI deposits due to partly complacency and partly global perception of RBI policy stances unsettling India’s zone of comfort. By increasing repo rate by 50 basis points, the RBI has provided only a part upward push to Indian yields. Opportunity is a wasting asset. Of course the wise people managing RBI will synchronize policies to India’s opportunity call but that may be too late to lose the small window of opportunities transiently offered. May be RBI as usual is waiting for a shock like more hawkish USA policy to escape from criticism around depreciation of rupee exchange rate.

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Failure in inflation front has devastating consequences for countries. Hyperinflation occurred in Germany?in 1920, leading to great social unrest. The purchasing power of money?fell so low that the then German currency, the Mark, became cheaper than firewood. Hitler blamed the Jews for spiralling inflation, which helped pave the way for the horrible holocaust.

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The Zimbabwean dollar bank note holds the record for the greatest number of zeros shown (100,000,000,000,000).?The political upheaval was for all to see with Robert Mugabe acting like a hoodlum. Hungary?holds the record for the largest banknote ever issued, but its banknote did not depict all the zeros, the amount was spelled out in words only. The prices of essentials doubled every 13 hours. They lost their European peer life style for ever. If inflation is not controlled in time and players remain in denial mode, this is what happened in history.

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Even USA has experienced two currency collapses due to inflation. The first was the Continental Currency during the Revolutionary War and the second was Confederation notes during the civil war. Consumers be alert and Government be prudent when RBI is looking into its pass-through problems.

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Kailash Chandra Mishra

M 7381107000