Indian General Elections, the most colourful carnival of democracy on the planet, have had one theme running common all these years since Independence – price rise. But that’s almost absent in 2019.
Days of prices of foodgrains, vegetables, fruits, television sets, automobiles and refrigerators pinching the pockets of consumers appear to be behind with hardly anyone including the main opposition party – Congress – complaining about it.
Inflation as measured by the Consumer Price Index is below the government set target of 4% for 8 months in a row despite volatile crude oil prices and not so sufficient rains in many parts of the country.
But the chief of Monetary Policy Committee that’s entrusted with the job of keeping price rise at 4% with a room to move two percentage points on either side, and his deputy on Mint Street have different views on what the future holds, despite predictions that the gauge would be at 3.5-3.8% in the second half of the fiscal year.
Every economy undergoes some structural changes that alter its dynamics -either for the better or for the worse. Having lived through doubledigit inflation for the best part of the previous decade, is it different now? Is inflation a thing of the past for India? Although consumers have been beneficiaries of low inflation, there is a flip side to benign prices that may be playing out in the economy – farm incomes.
“Inflation has been and remains a key issue,” says Jahangir Aziz, head-EM economics at JPMorgan. “We don’t see it because we are just focused on urban households. The continued food disinflation…has resulted in the terms-of-trade that farmers face to sink to their lowest in over 35 years.”
India like most emerging economies was often struck by soaring prices due to poor capacities, infrastructure bottlenecks, and fiscal profligacy. Agriculture was at the centre of it with over 60% of farmers depending on monsoon rains without sufficient irrigation.
International developments such as crude oil prices also played a vital role in pushing the prices and a lack of anchor for central bank policy making with constant political meddling led to ineffective monetary policies.
Things began to turn once Raghuram Rajan took up governorship in 2013. He set up a committee under Urjit Patel to relook at monetary policy making. It suggested a Monetary Policy Committee structure with outside members in it with the sole focus on inflation targeting.
The Modi government operationalised the MPC structure and that led to a single minded focus on inflation, leading to very high interest rates that drew criticism.
Nearly three years after inflation that was the highest among emerging economies in 2013, it is the lowest now.
“Definitely there are structural changes in terms of breakdown of inflation in India,” says Sonal Varma, economist at Nomura Securities. “Number one is the move to flexible inflation targeting and the role it has played in terms of anchoring expectations.”
While the MPC has been unwavering in fulfilling its mandate, the government on its part declogged a part of the agricultural economy that was suffocating from socialist era policies that helped foster an oligopolistic structure.
Despite state governments having a more dominant role in the agriculture economy, the Union government persuaded 14 states to amend the stifling Agriculture Produce & Marketing Committee Act that enabled farmers to skip middlemen who controlled the mandis (warehouses).
“We believe the key driver of the collapse in vegetable prices has likely been the deregulation of markets,” says Prachi Mishra, economist at Goldman Sachs. “Vegetables inflation declined sharply in 2014 and 2015 and has stayed low since then.
The timing of the sharp drop in vegetables inflation coincides with the delisting of vegetables from the Agriculture Produce and Marketing Committee Act (APMC) in 14 states.”
Food has been the main driver of inflation accounting for nearly half of consumer spend for most of the households. But that has been dormant for about four years now.
Of the 108 months during 2000-09, food inflation was above 4% during 56% of the months, and greater than 10% during a quarter of the months, says Goldman. After 2013, food inflation has been below 4% for 55% of the months under consideration.
The average inflation rate for vegetables decreased from 31% in 2013 to 1% in 2016.
Given that the meteorological department is forecasting a less than normal monsoon, will food price rise come back to haunt?
“The government holds large buffer stocks of key food staples and has the option of selling these stocks in case of any major upsurge in food prices,” says Siddhartha Sanyal, economist at Barclays. “Normalisation in perishables prices, which have been falling, cannot be ruled out; but it is unlikely to be disruptive for the broader inflation basket.”
On global stage
Inflation targeting, a concept borrowed from developed markets, has done well for India as far as keeping the price rise well within acceptable range.
But central banks, including the Federal Reserve, are battling a different problem. They are not able to push inflation to the target of 2% since the Global Financial Crisis. At the same time, in India too, inflation is below the target. Does that mean RBI is on a par with the Fed?
“Despite this success of lowering inflation, drawing comparisons to advanced markets may not be correct,” says Shubhada Rao, economist at Yes Bank. “The decline in inflation has been accompanied by correction in global crude oil prices from over $100 per barrel in 2009.
Second, and more important, India’s inflation is still a supply-side driven phenomenon as against more predominant demand-side factors in the advanced economies.”
The Federal Reserve this year had to make a U-turn in its policy stance after signaling a series of interest rate increases last year. This was due to the fact that economy was slowing and that inflation was nowhere near the 2% goal it set for itself despite a record low level of unemployment, high fiscal deficit, and money from the quantitative easing still sloshing around.
This raises questions about monetarists’ belief that inflation anywhere and everywhere is always a monetary phenomenon. In advanced markets, economists attribute low inflation to productivity improvements because of advancements like Amazon Inc’s delivery and ageing population that is reluctant to spend.
But India is different with millions still below the poverty line and a creaky infrastructure and a growing reserve army of labour without jobs that’s essential for raising the standard of living. Livelihood, though, may not be as much of a struggle as it was before liberalisation began in 1991.
Has inflation really come down on a durable basis?
“I don’t think it is similar, even as there are some common themes such as globalisation, more competition and keeping manufacturing prices down, (besides the) role of technology dissemination resulting in efficiency,” says Nomura’s Varma.
“If you look at the undershooting globally, core inflation (price rise excluding food and fuel) has also been running quite low. In India, core is above 4 %.
MPC’s risk puzzle
The answer to whether inflation has been conquered lies in the voting pattern of members seen during the last MPC meet. While four voted for a rate cut, two – independent member Chetan Ghate and Viral Acharya wanted to maintain status quo.
Governor Shaktikanta Das, chairman of the MPC, voted for a rate cut for the second straight meet while his deputy Acharya did not. The two read the inflation and growth data in different ways. While Das believes growth needs to be given a push, Acharya says it is accelerating.
It may be tempting to theorise that the gap between the new bureaucrat-turned Governor and his academic-turned deputy is widening, economists see the MPC turning vibrant for the betterment of policy making.
“The last thing we want is that the MPC becomes an echo chamber,” says Aziz of JPMorgan. “Some remain stuck to what happened in the past to draw their inferences about interest rates, while the others are focusing on how things will evolve over the next 6-12 months to make their calls.”
The six MPC members are not only guided by the past data on inflation and also the forecast of where the prices are headed in the next year.
The central bank’s forecast is at 4.1% for next year, but like all central banks have experienced the reality may be different from the expectation – either on the upside or downside.
“We need to appreciate the fact that policy makers do not have the benefit of hindsight and work with a forward looking framework, some of which is subjected to elevated volatility from global factors like commodity prices and exchange rate,” says Rao of Yes Bank.
Apart from global factors, policies of the government determine the state of prices in an economy. It can be a price spiral like in Venezuela or tame like in Germany. Given that elections are round the corner, political parties have promised many welfare schemes that could impact inflation next year.
The NDA government may have broken the merchants’ control over farm produce, history shows a government led by Congress tends to be liberal in doling out inflationary schemes like high minimum support prices for farm products. This time it has promised a basic income transfer plan that would require as much as Rs 3.5 lakh crore a year, straining the fiscal balance.
It is the tango between the RBI and the government on synchronising the objective of price containment that has delivered low inflation over the past four years. For it to sustain, policy makers have to persist with the objective of low inflation, failing which the gains of the past few years could be wiped out in no time.
“People seem to overlook that this structural decline in inflation may have something to do with the inflation-targeting credibility that central banks and the RBI have earned the hard way,” says Aziz. “A change in central bank objective, i.e., it will not hike until and unless inflation has become entrenched, could well erode this credibility, unanchor inflation, and start a inflation spiral. Would India like to risk this?’’
The political will of the next government to remain committed to inflation targeting will make the difference between whether India is seen as an unreliable emerging economy, or an evolved one that plays by the rule book.