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Defeating the Hydra- Measures of Inflation Control

June 13, 2008


There is an interesting article on Livemint, a column called Cafe Economics, linked here.
But the overall tone of the article, just got me more infuriated than thinking. It started with a mention of historic spiraling inflation in India suffered in 1943. It was a horrific turn of events, a totally man made one, which led to millions of people in Bengal and other parts dying [For famines: give this a read].
Inflation @53%!

Then the article very swiftly moves to Zimbabwe’s 66,000% inflation, and thanks providence for not having such a sham of a fiscal control. Comparing henceforth with other historic inflation blunders of China, Japan, Korea etc, the article very conveniently [and with some back slapping] concludes India in a considerably comfortable position and even to a certain extent talks about how we suffered through a 20% inflation rate for 2 years [1970’s] and in an almost guilty fashion ends with a underlying tone that said “Hey-you-didnt-suffer-anything, -we-sufferred-a-lot.You-should -be-seeing-mid-teen-inflations-soon”

Well, thats what I understood! Mind you I have a big disclosure to make, I was infuriated. So apparently I saw many non-existent tones with perhaps doesnt exist. But, the more I give it a read the more it tells me of the same feeling. Strange isn’t it?

But I have a basic question, does anybody in his sane mind think, 8.4% is too low a rate to have? Does anybody think, that controls and measures should kick in only when it touches a mythical level of say 10%,12% or heck as the author says mid teens?
I disagree. And I am shaking my head and thinking.

Any mature market economy, and I repeat any of them, can’t do with inflation anything higher than 2-2.5%. Comparing with Zimbabwe or postwar Japan may make our position look softened, but back slapping and complacency is not the way for Indian system to go.

Even a 5% inflation rate, as set by RBI is way too high. And I really don’t know why there is not an effective system of inflation-information in public domain.

It has been claimed that, with 93-94 as the base year, has weights of 22.025 for primary articles, 14.226 for fuel etc and 63.749 for manufactured products[as of 2004]. I don’t think it still is the same and if it is, then apparently it is not the way to go forward. Our WPI is long accepted as deserving an overhaul, for its weak synchrony with the ground realities, yet nothing has been done.

More importantly , the government’s entire modus operandi rests on “Inflation changes-> is-it-higher-than-what-I-expect?- Yes?-go-into-price-control-mode. No?-rest-in-peace This is in effect a very bad way to do fire fighting. The focus is on actually putting a band aid on a festering wound rather than effectively curing it.

Secondly, our inflation system is a weekly point to point over annual range, but this in itself is prone to a huge amount of momentary fluctuations and spikes. Mature fiscal policies dictate, having monthly reports which is in no way less effective than the present one.

More importantly, RBI often hikes interest levels to counter inflation. But my question is, is the present inflation scenario like the previous ones? Surely, this is not a usual run-of the mill supply side inflation. The core-inflation [excluding food and fuel prices] has not changed, but this entire shock is being propagated for the rising price of oil [which is a matter of a different post in itself], and to deeper extent as the manifestation of the slowing down of global economy.

And given that, global economy is slowing down, what exactly is the rationale behind maintaining a sky high interest rate? Can’t it be seen that, this is just going to worsen the situation, making India less favorable for foreign investment?

And largely, and more importantly, a noticeable differential interest rate [compared to two nations] just changes the entire look and feel of investment system. And who knows, if it is sufficiently high, a totally different trade systems like Yen Carry Trade may emerge, during this period, which does nothing but weaken the underlying fundamentals.

Raghuram Rajan and Ajay Shah are two proponents of changing the entire jurisdiction of RBI, to inflation control and it in fact reflects immensely with what other mature economies have.And more importantly, Ajay Shah, is a big believer in letting the underlying currency pegging go, and let the rupee have a 10% or more of appreciation. I don’t know [for the lack of any informed opinion] how good a method this is, but certainly hiking from 7.75% to 8% the repo rate, is not the way to go forward

[The author takes a passionate interest in business,technology and strategy. An avid Elliott Wave Theorist,and an analysis blogger. When he is not blogging on markets, technology and their business issues, he spends his time conceiving and executing projects for a hi-tech electronics startup based out of South India. Mail him at sohamdas at gmail dot com. He is listening]

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