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Inflation, Interest Rates And Common Sense

India's wholesale prices rose a faster-than-expected 0.79% in May from a year earlier, mainly driven by higher food prices. Sutanu Guru takes another look at the vexatious issue of food price inflation

Photo Credit : Reuters

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Ominous, if not bad news keeps coming for the Narendra Modi regime. Latest estimates suggest that food inflation in May 2016 was a disturbing 7.55 per cent on a year to year basis. This ensured that retail inflation as measured by the consumer price index was at a 21 month high of 5.76 per cent. That's not surprising because food items constitute almost 46 per cent of the weightage in the consumer price index. Food inflation averaged 2.7 per cent between July and September, 2015. That food inflation is worrisome was also reflected in the recently released wholesale price index figures in which food inflation has zoomed up by a whopping 7.88 per cent. Hugh food inflation has finally dragged inflation based on the wholesale price index to positive territory at 0.79 per cent. For well over a year, wholesale inflation has been negative.

Pulse prices at a retail level grew more than 30 per cent in May 2016 as compared to last year. Milk prices have been raised recently. Fuel prices too have been raised recently. Then there is the 0.5 per cent Kisan Kalyan cess that will put more pressure on retail inflation. Finally, vegetable prices have increased at a rate of about 11 per cent while potato prices registered a rise of about 60 per cent. If you are someone who actually goes out to buy vegetables or even orders them online, you won't need statistical indices to tell you that inflation is a worry. Tomato prices hover between Rs 60 to Rs 80 per kg. We're it not for the crashed prices of onions, food inflation would have been far higher.

Economists and analysts have studied these numbers and come to the conclusion that there is simply no scope for RBI governor Raghuram Rajan to cut interest rates any further. The central bank has fixed a target of of 5 per cent retail inflation by March, 2017 and 4 per cent the next year. There are fears that sugar prices, which have been depressed because of excess production and supply for more than a year, are going to become another embarrassment for the government in the near future. Sugar production is estimated to decline from more than 28 million tons in 2014-15 to just about 22 million tons in 2016-17. Domestic demand for sugar in India is more than 25 million tons. You don't need to be a rocket scientist to figure out where sugar prices will head. So the consensus is that there will be no further cuts in interest rates.

But this author has always wondered if interest rates have any impact whatsoever on food prices. This seems to be one area where the RBI seems to be getting it wrong for almost a decade. Most people describe Raghuram Rajan as a "hawk" when it comes to monetary policy and interest rates. But even his predecessor D Subba Rao was a hawk. In fact, he kept raising interest rates to curb growing inflation. There was hardly any impact as food inflation remained stubbornly high and the unusually high interest rates had a disastrous impact on GDP growth rates. Forget the jargon. How will raising interest rates lead to lower prices ( or even lower rates of increase in prices, as inflation is defined) of potatoes and vegetables? What impact will interest rates have on sugar prices when demand will inevitably exceed supply maybe by the beginning of the festive season this year? And if disgusted farmers don't grow onions because of the absurdly low prices, can interest rates stop onion prices from again zooming close to Rs 100 a kg?

The bald fact is that stubbornly high food inflation can be directly linked to a huge success story for India. In the 21st century, more than 300 million Indians have left poverty behind and joined the ranks of aspirational lower middle classes. Their diets have changed. Thanks to higher disposable incomes, they consume more milk, eggs, vegetables and meat, something they could never afford while living below the poverty line. There is simply now way that hawkish monetary policies and interest rates will change this fundamental equation. The answers and solutions lie elsewhere; definitely not with the RBI.


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inflation wpi interest rates rbi food prices