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Debate: Is RBI wining the inflation fight?

The optimism over a growth revival has received double jolt — inflation remains stubborn and growth is barely crawling.

Retail inflation in August slowed only marginally to 7.8 percent against 7.96 percent in July. Vegetable prices are the main culprit once again. Vegetable inflation has remained high at 15.5 percent in August against 16.8 percent in July. As a result food prices remain elevated at 9.16 percent. However, thanks to the government offloading its food grains, cereal inflation remains steady at 7.39 percent in August.

But all is not lost; core inflation has eased considerably even dropping below 7 percent compared to 7.4 percent in July. What about growth? India’s factories are still not out of the woods. Industrial production in July slowed to its lowest level in 4 months, barely clocking any growth – coming at a mere 0.5 percent.

Manufacturing growth contracted by a percent and capital goods growth shrunk by nearly 4 percent. The fall in core inflation is a sign of weakening demand and that is reflected in the 21 percent contraction suffered by consumer durables.
All in all, the room for the central bank to ease rates to spur growth looks almost negligible in the near future as inflation fight is far from over.

CNBC-TV18’s Latha Venkatesh talks to Dr Pranob Sen, Chairman of the National Statistical Commission, Chetan Ahya MD & Chief Economist Asia Pacific at Morgan Stanley and A Prasanna, Chief Economist at ICICI Securities Primary Dealership Unit to find out their views on whether even at 7.8 percent the inflation battle is largely won.

Below is a verbatim transcript of the discussion on the channel

Q: I am presenting some data to you. I want to point out that vegetable inflation in July this year and July last year were equally at 16.8 percent or 16.5 percent. However if you look at the trajectory of vegetable inflation this year from 16 percent it has fallen to 15.5 percent in August and last year it actually went up to 26 percent in August and then 35 percent, 45 percent, 61 percent and 38 percent in the remaining six months of the year. Basically shooting up, this despite a fairly good monsoon last year. Likewise let me compare cereal inflation. Cereal inflation was a mighty 16.3 percent in last July, this July it is already just 7.5 percent. August as well it has fallen actually to 7.3 percent but last August cereal inflation shot up to 14 percent and then remained elevated at 12 percent from September to December 2013. So, cereal inflation was not controlled despite a very good kharif last year. As a result food inflation which started off at 11.2 percent in July last year peaked at 14.7 percent in November before receding somewhat to 12 percent in December. Fortunately this time even in July we are at 9 percent and in August we remain at 9 percent. With this data are you getting a sense that food inflation is a far smaller problem this year?

Sen: You can’t quite say that yet. What last years data is showing is the damage that a high Minimum Support Price(MSP)can do because it not only pushes up cereal inflation but much worse it actually diverts land away non-cereal food crops to cereals which is what causes the pressure on vegetables.

This year the monsoon has been worse but the monsoon hasn’t been as bad, it has been delayed and it has made up a lot of ground towards the latter part of the season. We also have a situation where the MSP has not been increased very dramatically. So, what we can hope for, one can’t say that one really expects it as yet because the data isn’t in, but what one can hope for is that the late sowing will have a depressive effect on cereal production. So, we are not going to have a lot of land going under cereals and hopefully some of that land will go into vegetable production and will ease the problems at the vegetable front. So, we are not going to hopefully see the kind of accelerating inflation we saw in vegetables last year.

Q: Do you think that cereal inflation may not remain at just 7 percent. Do you fear that it can still rise as we get to the delayed effects of a lower output compared to last year?

Sen: Not necessarily. The government has made a very clear statement that they are willing to offload up to 15 million tonne of food grains. If they actually keep to that promise cereal inflation can actually be brought down to sub 6 percent.

Q: You have been speaking to a lot of economists and policy makers in Delhi as well. What is the sense you are getting, has the government been more active in offloading grains so that despite a poor monsoon there has not been a huge effect of vegetable prices on cereal inflation, do you think we are in a much better position than last year despite the weather not being very kind?

Prasanna: Yes the government has been more proactive in releasing food grains or rather in announcing that they will release food grains. I think they have been pretty consistent on that score. So, that has definitely helped manage expectations. However as far as vegetable inflation is concerned you should remember that last year we had a severe shock in the onion crop, so that was perhaps a one off last year. To that extent we may not see a recurrence of that this year, I think definitely we are going to see much lower inflation.

Q: Didn’t we almost see a tomato shock?

Prasanna: Yes but that wasn’t as widespread or it did not last long enough. Onion shock last year lasted long enough. This year again there are rumblings that potato and onion prices are going up again. So, we have to wait and watch on that.

Q: So, you are saying you won’t call victory on vegetable or do you want to at least concede that despite a bad monsoon we have some how ensured that vegetable inflation doesn’t become a generalized cereal and all food inflation?

Prasanna: What I am trying to say is the situation is definitely better than last year. So, if you want to call that a victory it is a victory but it is not a man made victory. I think we have just been lucky that’s all.

Q: We have been lucky that it is not a terrible vegetable inflation?

Prasanna: That is right.

Q: How much credit would you give the management? I want to know if any of you are giving credit to the government for ensuring that the vegetable inflation doesn’t become a food inflation because more from the governments buffer stock have been offloaded. Is that the impression you are getting?

Ahya: I would take a slightly bigger picture story on inflation because it is not just food but also core inflation is low.

Q: I want to keep the overall global commodity and fuel inflation fall to the next question. I just want you to ponder on whether the government has managed the vegetable inflation better and not allowed it to pour over to a general food inflation?

Ahya: There are two key causes for food inflation to be high. One is the MSP prices have been kept low. Second is the under appreciated point on rural wages. If we compute on a implied basis rural wages inflation has probably gone down to around 11-12 percent year on year now. We have a data series break so it is a bit of a guestimate on the basis of the new series combined with the old one and that has come down to. So, the input costs for food production has also been systematically going down. We are not inflating demand for food by giving compensation to rural workers without getting any output against that. So, that is also systematically helping bring down food inflation. So, I would say both these factors are playing on it. We have been lucky that the weather problem really didn’t get out of control and so that is the third factor probably I would list as the one which is helping food inflation to be less painful than what we had seen last year.

Q: Would you agree that vegetable inflation in the first place was never so bad. So, it is not really a government victory? Secondly are rural wages genuinely lower? Do you think MSP plus rural wages and offloading of Food Corporation stocks or buffer stocks have together actually controlled what could have been as bad a problem as last year?

Sen: As far as rural wages are concerned they have been trending down for a while now. So, that trend is continuing. However on the positive side the rural wage inflation continues to ensure that rural real wages are growing, they are not actually shrinking which is a good thing for the demand side.

The real issue that we need to keep our eyes on is that as far as the consumer price index is concerned the market prices of food grains accounts for about 75 percent of the total food grains weight. So, it is the market price for food grain and not the PDS price that matters. As far as the market price is concerned the government has to reiterate its stand that it will intervene and make sure that cereal inflation does not go up. I think that credibility does exists at the moment.

Q: Have they been offloading more than they did last year?

Sen: They haven’t offloaded very much, they have just made announcement that when necessary they shall. At the moment cereal inflation is not at an alarming level.

Q: Do you think food inflation can still rise from 9 percent and towards 10 percent like it did last year, go from 11 percent to 14 percent when it peaked in November. If not 14 percent is the trajectory still likely to be higher in food?

Prasanna: Not necessarily. I think what we are going to see is the trajectory is actually going to be lower. Vegetable prices seem to have peaked. So, if that situation holds and then in November you have this base effect quite favourable, so food inflation could drop quite significantly from here.

Ahya: We expect food inflation to continue to decelerate. I am sort of boldly making the call that 12 months hence you would realize that food inflation has got completely in control because despite all the government officials denying I think rural wages is the invisible hand which will control food inflation going forward as well.

Q: Your trajectory for food inflation 6 months or 12 months down?

Sen: The base effect is important. Next three months I would say certainly would trend down quite strongly. After that it becomes a little bit more of a question mark, whether it will continue to trend down or it will kind of stabilize somewhere at around 6.5 percent range.

Q: The other trigger for inflation as all economists have been saying has been the fisc. Do you think it is a very well managed this time probably because of global crude prices also helping but from that end are we going to get some help in terms of lower aggregate demand or lower fiscal push towards inflation?

Prasanna: That is true but we also should remember that over the last two years also even without too much of help from the global factors we managed to keep the fiscal deficit on target although probably the way it was done was not a pretty way. However I think this year yes couple of factors are going to help. One is the crude prices being lower which means the subsidy burden should be lower. Also disinvestment is going to get a big push this year thanks to how the market has behaved and also because this government is more committed to disinvestment. So, both these factors should definitely help on the fiscal side.

Q: There was an economist in my show making the point that actually the government has cut its expenditure considerably. Are you noticing any such trend in the first four months of the fisc?

Prasanna: There were couple of factors. One is earlier we had this Vote on Account then the spending kind of got constrained till the full Budget could get passed. Also this year the way the planned expenditure is allocated, it is first routed through the states, so there could be some lag in that. So, I don’t think that too much should be read into that.

Q: I want to get the global factor in. Crude obviously below USD 100 per barrel and we are given to understand by several experts that it might if anything trend towards USD 90, not much upside seen given the shale gas availability and overall demand stagnation in big economies. As well other commodities, coal, iron ore, are you getting a sense that the world commodity scene is going to help us a lot including global food prices in helping our inflation lower?

Ahya: The fact that China’s investment demand continues to slow and they are 50-60 percent of the global commodities demand that is helping to keep commodity prices under check. This trend has been under way for some time but unfortunately because we had a large rupee depreciation in terms of its transmission effect to the domestic inflation it has been delayed. However now that the currency has been stable the effect is coming through in the rupee terms in commodity prices within the domestic market as well.

Q: You were speaking about core inflation, could you elaborate? Where do you see it trended, what has brought it down?

Ahya: We think there are lots of factors which are under play. The first one is the fact that the government has cut expenditure to GDP by almost 2.5 percentage points since the peak that we had seen when fiscal deficit was 10 percent. Second one is rural wages which were averaging around 18 percent between 2009 and 2013 have now slipped to about 11-12 percent. In the last 6 months itself rural wages seem to have slipped even more from 16-17 percent to this 11-12 percent number. So, we have seen a much faster declaration in the last 6 months. So, that is helping too.

Third is global commodity prices which you highlighted as well. Fourth is that we have seen compression in domestic demand. It is not as if domestic demand is very strong. So, all these factors are helping to ensure that you have food inflation as well as non-food inflation gradually decelerating. It has just been unfortunate that we had this weather problem again this year. If we didn’t have this weather problem then we would had really seen a much faster deceleration of inflation. April and May I would urge you to look at those two months data points. Core inflation was decelerating faster then as well as it was a broad based deceleration in inflation. So, we are very optimistic that headline inflation will be reaching 6 percent range somewhere in the second half, certainly in Q4 of 2015 well ahead of RBIs target of 6 percent in January 2016.

Q: Do you share that optimism?

Sen: Up to a point. Much depends on what happens to core inflation. My sense is that as far as food inflation is concerned given the structural rigidities that we have it is not going to come down below 7 percent. May be somewhere in the 7-8 percent range which essentially means that the core has to come down to somewhere sub 4 percent for you to get that 6 percent target.

Q: What would your thoughts be both on core and overall inflation? Would you share Chetan’s optimism?

Prasanna: On core inflation we have also been forecasting that it will trend lower. I think it will come down further and probably by next year it should print at 6 percent or slightly lower than 6 percent also. What has also helped is in India because of the way the index is constructed I think petrol and diesel prices are part of core CPI. So, this crude fall should help that further. That apart this is a lagged effect of slowdown which we have been having in the economy and that is why we are seeing core inflation falling.

However as far as overall inflation is concerned I would agree with what Dr Sen is saying. I think structurally we have not seen any improvement on the food inflation front. The government has not done anything. What it is trying to do is just to contain. We are not seeing any structural changes happening and unless and until that happens I think sustainability of lower food inflation is questionable. So, I wouldn’t get too optimistic that even if we hit 6 percent on headline level say some time next year whether that will be sustainable I think that still remains a question mark.

Q: What do you expect by way of RBI action? You are seeing a rate hike at all, I think that at least has to be ruled out from what you three gentlemen are telling me?

Prasanna: We also don’t have a view of a rate hike in any case even before this data. We always expected core inflation to trend down. We do think that overall inflation will be slightly below 8 percent by 2015 calendar Q1.

As far as the 6 percent target is concerned we still see some upside risks. However we think RBI would be prepared to wait and wait for the government to take more steps. So, they are not going to rush in to hiking rates at any point of time. So, we think we are still going to see a prolonged pause. So, for the next 12 months we don’t see any movement in interest rates.

Q: So, a likely next action is a cut and that will perhaps September next year?

Prasanna: Yes basically last quarter of next calendar year.

Ahya: We are expecting one symbolic rate cut in Q2 of calendar 2015 which is April to June quarter. We think that there will be a good amount of confirmation that the governor will be able to have in terms of hitting 6 percent inflation by that time. He had mentioned in a media interview that we don’t need to actually be at 6 percent, as long as we can comfortably see that he would be obliging with a rate cut.

I think the big picture story is 25 basis points is just a symbolic rate cut because we need to build real rates. The Fed rate hike expectations will also build up at the same time. So, the more important message would be no rate hike and more stability in interest rates.

Q: What are you expecting as the next RBI action and when?

Sen: I expect RBI to be in a pause mode. I am not quite as sanguine that there will be even a symbolic rate cut next year because if you think about the glide path we can confidently expect sub-8 percent by the target date next year. However, that 8-6 percent is going to be a lot choppier than people expect. So, the RBI is going to have to play it fairly carefully in terms of what they do with the rates.


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