India Wrestles with Inflation

Inflation or Deflation – One Nation two Stories

A random walk down Dalal street and every person you meet says that inflation is easing and high time the RBI cuts rates just walk a little ahead crossing a few by lanes and when you reach the main street, people say it is almost impossible to survive and everything has become so expensive, restaurants have stopped serving extra onions and have cut the dish quantity and cost of other essential things have really increased and the Government and RBI should do something ….

OOOPS

Who should RBI listen to the pundits  and analyst in suit boot or the common man who knows nothing about sophisticated terms like CPI ( Consumer Price Index) or WPI ( Wholesale price index) all he knows is the ground reality enough to make him survive and if possible keep some savings for a rainy day.

Price rise or price fall…. India wrestles with inflation-deflation puzzle.

Baffling figures prompt heated debates between hawks and doves on interest rate strategy.

Anyone studying India’s economy by looking only at its wholesale prices index for the past year could be forgiven for assuming that the country is in the grip of severe deflation, if not economic depression.

In August, the year-on-year change in the country’s WPI fell to minus 4.95 per cent, the lowest for nearly 40 years. The index has been in negative territory for nearly 12 months.

In the same month, however, the consumer prices index showed inflation of 3.66 per cent, and is expected to rise again in the coming months to about 5 per cent. Indians still fret about the price of everything from onions to medical care, and the gap between the WPI and CPI measures stands at more than 8 percentage points.

Disagreements over the significance of India’s puzzling inflation numbers, like those over its reported economic growth rate of 7 per cent a year, are fuelling a sometimes heated debate between monetary doves and hawks over interest rate policy.

Indian business leaders, supported by the government, complain about high real interest rates and the cost of capital. They are pleading with the Reserve Bank of India to slash its policy interest rate from 7.25 per cent, so that the economy grows and people start spending more there by giving boost to India Inc.

RBI (Reserve Bank of India) , on the other hand, is determined to force down India’s traditionally high inflation for the long term and is seeking to meet a CPI-measured inflation target of 6 per cent by January next year, although he is still likely to reduce rates by a further 50 basis points in the months ahead.

On the other hand the government’s feels, that challenge for India appears not to be price inflation but possibly price deflation and a blended measure using components of both the CPI and WPI, suggested annual inflation of 1.7 per cent if calculated for gross domestic product as a whole and just 0.1 per cent for gross value added, excluding the distortionary elements of indirect taxes and subsidies. In a situation like this, to exclusively focus on the CPI makes no sense, contrary to what the respected RBI governor feels.

It is almost impossible to have a perfect inflation index for all concerned in the society but India’s WPI is not a good indicator of future CPI because the two indices measure different things: WPI measures prices of tradable goods, including those of fuel and basic manufactured products such as steel, which have fallen sharply on international markets, while CPI includes services such as health and education.

CPI would nevertheless have fallen further, if India was not burdened by chronic supply-side bottlenecks that government needs to tackle. The government expects CPI inflation to rise, especially after demand is stoked by civil service pay increases to be awarded by the forthcoming Seventh Pay Commission.

The continuing large gap between WPI and CPI is a puzzle: This diverging wedge is not completely understood clearly in a complex economy like India.

While hawks and doves pursue their agendas with the help of their preferred inflation indicators, investors and analysts seem to be leaning towards the notion that India is afflicted neither by the drastic deflation indicated by WPI nor the high inflation usually reflected in the CPI.

There is a lot of anticipation a large rate cut to the tune of 50 basis points by the RBI in its next meeting as India Inc and the government is holding RBI responsible for the lack of growth and they feel that a rate cut would really boost the spending power and people would open their purses. Even if there is a good rate cut by the RBI, what is to be seen is how much of that cut is actually transmitted to the end users by the respective banks.

Let’s take an example if the rates do decrease and the banks transmits a 25 basis points decrease in rate (0.25%), the difference on a home costing INR 150 lacs would be INR 30,000 a year or INR 2,500 a month, on a car of INR 10 Lacs the savings would be INR 2,000 a year or INR 167 a month, in both cases assuming that the loan amount would be 80% of the total value.

Would this be enough to encourage the people to but more homes, cars and spend much more or would such decisions be based on overall macro stability business outlook and growth which looks bleak overall.  With head winds from China , Europe and with the country with weak monsoon which has hurt lacs of farmers , the common man is not going to start spending even with a 50 basis points cut.

To buy a car this festive Diwali season or next would a common man wait for the next year as the interest rates may go down; sure he will save money to an extent in the interest payment as the rates would go down but what about the cost of a car?? Has it historically ever been recused to a large extent? With all the analyst and pundits on Dalal Street talking of a commodity super cycle at its all-time low with metals, crude at all-time lows has the cost of taxi’s or tuk tuk reduced; not really ..

Hence it is important for RBI to pay attention to the Main Street rather than Dalal Street which analyst in suit boots and it could oblige the government and India Inc with a 25 basis point cut to test the waters but it needs to trot carefully.

_ Farzan Ghadially