RBI: wake up, smell the coffee

These are the facts of the Indian economy that the RBI is confronted with for its meeting on March 19 for the future course of monetary policy: Economic growth the lowest in the last decade, and among the lowest in the last three decades. Consumer price inflation, especially food inflation, the highest in over two decades. After the 1991 reforms, consumer price inflation has averaged 7 per cent per annum. The last five-year average — above 11 per cent, with peak inflation above 15 per cent in 2009 and the lowest being just shy of 9 per cent in 2010. This is not the occasion, either for us or the RBI, to go into the causes for this inflation. The determinants are more than well known — reckless "welfare" expenditures that bear the blunt signature of the leader of the Congress party, Sonia Gandhi.

There will be many occasions to go into the faultlines of Sonianomics, though it is unclear whether the moniker should have any association with the word economics. But that discussion is better left for the near future. At present, it is critical that the RBI make the correct decision on March 19. In my opinion, and what the facts documented below suggest, the RBI should cut rates by 50 basis points, with the promise of much more if Sonia Gandhi's government begins to behave responsibly on the major generator of food and CPI inflation, the procurement price of food grains and in particular rice, whose policy announcement is expected next month.

Several data relating to growth and inflation are presented below. My apologies, but I want to leave no data unmined. The RBI has proved itself to be more than adept at changing goalposts, and surprisingly, still scoring several self-goals. Among all the economic data available, there is one indicator that says that the RBI should not cut rates — it is the elevated 10 per cent plus level of food inflation. (Food has an approximate 50 per cent weight in the CPI and is proxied by it in the discussion below). But the "should" comes with a caveat — that the RBI believes that monetary policy, in the form of overnight interest rates, can affect food inflation. If it does believe that, then the RBI should offer at least minimal evidence to support its claim. It should explain how CPI inflation decreased from a 13.7 per cent level in April-June 2009, when the repo rate was at a low 4.75 per cent, to a 10.6 per cent level when the repo rate hit its peak 8.5 per cent rate in October 2011. CPI inflation remains close to its 10 per cent plus level today, and the repo rate is lower by 75 basis points at 7.75 per cent.

... contd.

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