“The ‘core inflation rate’ is relevant for those who neither eat nor use energy.” — Floyd Norris in The New York Times

The Monetary Policy Statement for 2013-14 to be issued by the Reserve Bank of India (RBI) on May 3, 2013, may perhaps be the last major formulation for the Governor whose term is expiring in early September.

Many would wish he continues at the helm to guide — especially those who do not as yet see light at the end of the tunnel of economic gloom.

The latest year-on-year industrial growth and retail inflation statistics for February and March 2013 at 0.6 per cent and 10.39 per cent, respectively, continue the earlier trend. Exports declined by 1.76 per cent in 2012-13 over the previous year.

The current account deficit for 2012-13 may be not less than 5.5 per cent of Gross Domestic Product (GDP), the growth rate of which may turn out to be around 5 per cent.

The RBI faces, once again, the difficult task of choosing between growth and price stability. The Governor could leave his stamp on monetary policy by undertaking a thorough evaluation of the Bank’s approaches in the recent period and blaze a new trail by doing some out-of-the box thinking.

Money Supply

Some of the suggestions made here are what I have been saying over the years but their recap in this article, with updated thinking, may be helpful for the authorities who generally undertake wide consultations before policy making. The Budget for 2013-14 has assumed a GDP growth of 6.5 per cent and inflation rate of 6.5 per cent. As the Finance Minister explained at a press conference it means a nominal GDP growth of 13.4 per cent (not 13.0 per cent).

I have already discussed the hazard of aiming at the nominal GDP, advocated by the market monetarists (“No case for monetary policy easing now, Business Line , March 15). The question is on the RBI estimates for the two crucial macro variables — GDP growth and inflation.

While one can understand different estimates being made by private and international agencies, how does it help the consumers and producers in taking decisions if there are different official estimates from the RBI, the Finance Ministry, the Planning Commission and the Prime Minister’s Economic Advisory Council? Can the four agencies not exchange their ideas and come out with one estimate on each variable, based on a consensus that would help entrepreneurs estimate demand for their products, and plan production and investment accordingly?

If GDP growth of 6.5 per cent is accepted by the central bank, then with the income elasticity of demand for money at 1.3, the Money Supply growth without inflation for equilibrium in the money market should be 8.45 per cent. Since the middle of the 1980s, the RBI has been adding 5 per cent to accommodate a ‘tolerable inflation rate’.

I have called it an unwarranted baker’s dozen that would only assure the nation of a minimum inflation of 5 per cent!

Even if the practice continues, the Money Supply growth should be around 13.5 per cent.

Would the RBI instead add 6.5 per cent, the New Normal for inflation, and make it 15 per cent? It would only be validating the Government’s expected inflation rate that would make the economy continue to suffer from inertial inflation.

Inflation

Is it really necessary for the RBI to put out estimates of Money Supply and inflation? Can it not keep its calculations for internal use and just say that the growth of Money Supply would be such that no worthwhile productive activity would suffer for want of credit and it would pursue the medium-term target of 3-4 per cent inflation?

So far, the Wholesale Price Index (WPI) has been the indicator for measuring inflation, although the Consumer Price Index (CPI) and other indices of economic variables are also taken into account in making policies.

That the WPI is the real measure of inflation for the central bank is brought out in the frequent references to the ‘core inflation’, that excludes food and energy prices, and the comfort taken recently that it is less than 5 per cent. A historical fact responsible for the use of WPI needs to be recalled.

Before the system underwent a drastic change, only WPI was available with a weekly frequency. The monthly CPI data for different groups of the population were released with considerable time-lags. Hence for quick policy making to deal with the emerging situation the WPI was chosen, although the policymakers were aware of its limitations.

Now, the revamped and comprehensive CPI is more than two years old and has stabilised; a time series is available for the purpose of year-to-year comparison. The WPI has also become monthly. It is time to switch over to CPI. Anti-inflationary policy should focus on the common man facing retail prices, not on the wholesale merchants.

The concept of ‘core inflation’ is a blind imitation of the US where the relative weights for food (13.7 per cent) and energy (8.6 per cent) in CPI for urban areas are different from those for the total for rural and urban areas in India (49.7 per cent and 9.5 per cent, respectively). ‘Core inflation’ in India should refer to food and energy only — exactly the opposite of the current practice.

The reason for the exclusion of food and energy prices in the US is that they are volatile, and not amenable to monetary policy action. Even there it has been criticised, as revealed in the quotation at the beginning of this article.

(The author is a Mumbai-based economic consultant)

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