In 1947, Shanmukham Chetty, the first finance minister of Independent India, commented in his Budget speech regarding persistent inflation and food shortage - "The only real answer to inflation is to increase our internal production and, thereby, close the gap between the available supplies and purchasing power." In 1974, the renowned industrialist late KK Birla, then FICCI president, wrote to then Prime Minister Indira Gandhi, criticising tight monetary policy and raising of interest rate stating, "Demand management policies have played out their role and should not be allowed to outlive their utility. Let us shift the focus now on revival of demand and, in particular, supply expansion." The logic is as relevant today as it was then.
Currently, the reason for tight monetary policy is high inflation as indicated by CPI numbers. In CPI, food and fuel have close to 60% weightage. In my opinion, food & fuel prices are as uncontrollable by RBI as 'atrocities against women' or 'Vitamin D deficiency in kids'. What then is the real purpose served by tight monetary policies? Is it the core inflation (other than food or fuel) or is it to manage inflationary expectations? Whatever be the case, there ought to be clarity on the drivers for policy decisions.
But I have another more important question. "Is food inflation really bad?" Most of us have economic dictums hard wired in our mind, since we studied Economics books of Milton Friedman and others at college. For instance, inflation is a demon that needs to be exorcised and tight money and high interest are the weapons for the same. When everybody from World Bank, global rating agencies, policy makers and government subscribe to the same theory about inflation and tight money, my argument may sound like heresy. It still deserves a patient hearing.
Most economists theorised the backdrop of early industrialisation where a few producers were exploiting a large number of consumers and making abnormal inventory profit. Inflation was a tax on the poor, dwindling their real income. However, food inflation situation in India is very different.
There are large numbers of fragmented small farmers who produce more than what they consume and actually benefit from inventory profit. It is the urban middle class that suffers. As all journalists live in urban areas, the subject gets unduly highlighted in the media. All of us know about the political upheaval caused by onion prices touching Rs 100/kg. However, the flipside of it did not get much publicity. When onion prices plummeted to Rs 1/kg, many farmers were driven to commit suicide. In fact, most farmer suicides have been driven by glut and steep drop in food prices. Therefore, if food inflation is the subject matter of monetary policy, RBI would be expected to contain the damage from food deflation driving farmers to penury and suicide.
It would be a subject matter of a different discussion, but the reality is that artificially low food inflation in the last six decades in India is the key reason for famers to perpetuate in poverty. Consider the paradox that farmer's per capita income has become one-third of his counterpart working in the industries or services since Independence, when every government and every budget has had subsidies and more than proportionate allocation for farmer and agriculture. Just as food and fuel inflation are beyond the control of monetary policy, so is the fall in their prices or deflation. If global crude prices fall and food inflation is lower due to the elevated base of last 3 years, we may well see headline inflation numbers falling. It would be a comedy of errors to attribute the same to the monetary policy. On the other hand, if it really affects growth, investment and thereby denies or delays job opportunities to millions, it would be a tragedy of errors for the nation.
I strongly feel that this is the opportune time for the interest rate cut to happen because global commodity prices have fallen, domestic core inflation is down, fiscal and current account deficits are trending down and sentiment for investment is improving. Bank credit growth has fallen below 10% per annum and investment cycle has practically collapsed.
When the current RBI governor took charge, his brilliant masterstroke and a calculated gamble of allowing FCNR B deposits did the magic. Everyone agrees that the move was the game changer and one of key building blocks for today's optimism. Today, Indian economy seems set to accelerate and rate cut is the timely impetus it needs.
Author is Chairman, India Infoline
The above article first appeared in The Economic Times dated 29 September 2014.