Slaying a demon called inflation

As the price of tomatoes nears Rs 100 a kilo, it is time to bring some of the strong vocabulary on inflation that was in vogue with some of the old-time central bankers. Savak Tarapore, the illustrious former deputy governor of the RBI, never minced words. He wrote way back in 2007: “Tolerating inflation is like dancing with the devil and those who argue against strong monetary measures to control inflation are the sinners of society.” The noted Prof P R Brahmananda had said: “Not caring about inflation is like going into battle without caring for the wounded, the dying and the dead.”

So, the policy repo rate hike of 40 basis points, from 4 per cent to 4.4 per cent, announced at an unscheduled Monetary Policy Committee (MPC) meeting called May 2 and 4, barely a month after the same MPC met and decided to keep the status quo (on April 6-8) is nothing short of a dramatic event. At the April meeting, the MPC knew that Jan and Feb 2022 retail inflation numbers had breached the upper tolerance level of 6 per cent -- they came in at 6.01 per cent and 6.07 per cent respectively. The March 2022 retail inflation numbers, which arrived later on April 12, confirmed the uptrend by coming in at 6.95 per cent. The unscheduled hike in repo rate along with a simultaneous Cash Reserve Ratio hike of 50 basis points to suck out “excess” liquidity, is a strong signal now that priorities have changed from protecting, supporting and even pushing growth while closely watching if not tolerating inflation to attacking inflation at the cost of growth. In theory, repo rate changes are expected to transmit (though in practice they may not always do so appropriately or speedily enough) through the money market to the entire the financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth, as the RBI puts it.

What happened to cause a sudden reversal of rate action?

The April inflation number was probably a key trigger, or something more out on the horizon that caused the discomfort and indicated more pain is coming. Whatever the reason, the fact is that inflation, which in the language of the ordinary person is a measure of the rising prices of goods and services, now takes on a new focus as it has reached levels that it can no longer be handled tentatively.

Under the current policy that goes by the acronym of FIT, or Flexible Inflation Targeting, the MPC (which is not the RBI though it is influenced by the RBI since three of the six members are from the central bank) has to keep inflation at an average of 4 per cent, with a leeway of two percentage points up or down, so that inflation between 2 per cent to 6 per cent is the range within which the MPC meets its mandate. The MPC has to achieve this while keeping in mind the objective of growth. In the words of the RBI: “The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.”

If the MPC crosses the 2 per cent to 4 per cent band on either side, it fails. If the average inflation level for three quarters in a row breaches the tolerance band, the MPC must explain its failure and how and when it can correct the situation. Some say there is a risk that this might happen for the first time in the history of the MPC, given that inflation for the coming months is expected to be above 6 per cent, the monsoons are an unknown factor yet and the international geo-political situation is on a boil. Fuel prices can be expected to go much higher. So, expect more rate hikes in the coming months; the demon on inflation will not be slayed easily.

The numbers and finer points of policy, however, never tell the full story of what is being felt in the market. To an ordinary citizen, any talk of inflation dynamics, the Ukraine war, a repo rate hike or an accompanying CRR rise to suck out liquidity, as was announced, have little meaning because the wallet is strained at every visit to buy staples. This pain cannot be easily understood by policy makers. Felt or lived inflation is inevitably worse than reported inflation. Inflation at work has therefore to be seen in the heat and dust of the markets, in the decisions that countless Indians make today to buy less or even turn away because prices are unaffordable. Prices are higher than they come across in press releases and data sheets. Ask any common person on the street and the heat of raging prices stands out.

What this demands now is not merely the technical and forced corrections that must be injected at top speed to stop the situation from deteriorating but a political leadership that responds to the pressures on the common citizen. It should be clear by now that the failed project on the farm laws sought to bring in monumental change against the wishes of the majority at precisely the wrong time. The intended scrapping of the laws against hoarding (and the strife the laws caused among farmers) could have made it even more difficult to control prices. Similarly, the new labour code will make it easier for businesses to hire and fire, making firms more efficient but exposing workers to the vagaries of the market, with nothing to fall back on.

In a recent report, the RBI wrote that economic progress rides on seven wheels - aggregate demand; aggregate supply; institutions, intermediaries, and markets; macroeconomic stability and policy coordination; productivity and technological progress; structural conditions; and sustainability. Seven is an odd number of wheels for a vehicle to move on. The missing eighth wheel is a sensitivity to the poor and a commitment to uplift every citizen so that the benefits of growth, slower if it be, are more evenly distributed. When it comes to making policy, it is important to realize that often “the choice is not between inflation and growth but between inflation and the distribution of income,” to quote S S Tarapore.

(The writer is a journalist and faculty member at SPJIMR)