Why RBI can cut no ice

It is a strange coincidence that RBI’s last quarterly monetary policy review this fiscal and EGoM meet on food falls on March 17th.

Last Updated: Mar 16, 2011, 15:21 PM IST

Rijo Jacob Abraham

It is a strange coincidence that RBI’s last quarterly monetary policy review this fiscal and EGoM meet on food falls on March 17th. Though the former event always remained outside the comprehension of common man, media has been prompt in celebrating it everytime. While the issues to be discussed in the latter has more direct impact on the price rise, it has been relegated to the inside pages of newspapers.

Besides, discussing the contentious issue of Food Security, the EGoM(Empowered Group of Ministers) meet will discuss export of sugar, which was a major driver of inflation last year. Will the decisions of the crucial meet give it some reason to vive for space beside the imminent interest rate hike?

The Reserve Bank of India (RBI) had raised its key interest rates for the seventh time in January 2011, since it signaled the end of cheap money in March 2010. Sucking out excess liquidity in the system was a criterion then, as inflation had emerged as a major threat.

The bank in the wake of financial crisis in 2008 had pumped in money to system as a monetary stimulus measure to boost up the economy.

But with excess liquidity also came the problem of inflation. It was argued that due to excess money in the system (availed through cheap credit) people are spending more. “More money was chasing fewer goods”, it was argued.
To compound the problem there was low Kharif crop production in 2008, thanks to erratic monsoon. But seasons of good rainfall later failed to ease the inflation. The inflation had remained high or at the best with marginal decrease. The annual point-to-point inflation in the Wholesale Price Index (WPI) for Food Articles stood at 18.32 percent and 16.91 percent during the weeks ending December 25, 2010 and January 1, 2011. Though after a gap of nearly three months, food inflation fell to a single digit at 9.52 percent for the week ended February 26, 2011 it was still above the comfort level.

The month ended February 2011, the headline inflation rose marginally to 8.31 percent from 8.23 percent putting pressure on RBI to raise interest rate.

The government has been blaming it on the supply side bottle necks. The government has been maintaining that the price rise was due to supply-side or demand-side pressures or a mismatch between the two. This argument is fundamentally flawed:

One, month to month annual inflation has been largely led by food inflation, though rise in fuel price has also caused inflation, but to a lesser extent. Food items are largely prone to speculative trading influences. Second, the inflation is not confined to food at large, but particular food articles. Prices have been consistently high for those food articles where there was little or no demand-supply constrains. High prices have kept attacking different food items at different times.
Curtailment of public investment in agriculture has also led to a fall in agricultural production. In the Union budget 2011-12, the government expenditure on agriculture was cut by 5,422 crores or 4.3 percent compared to the year ago period. While credit flow target to agriculture was increased to Rs 4,75000 crores from Rs 3,75,000 in 2010-11, it will benefit only the private sector enterprises, as it happened with last year’s Budget. Major subsides like the one for fertilizers were cut. Food subsidy was also cut by Rs 27 crores.

The Budget inflationary in nature, has shifted the entire responsibility of bridling inflation to the central bank.

April-November 2010 data reveal the total volume of agri exports increased by close to 10 percent. This increase has been led by significant growth in exports of pulses, guar gum and meat products –- commodities that have been in the eye of the storm.

On one hand, the government is consolidating corporate gains and cutting public spending in agriculture, but expecting the central bank to fight inflation alone is preposterous.