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RBI acted too late, it should have been thinking about inflation at least six months earlier, says former chief statistician Pronab Sen

While global prices have been going up, which is outside our control, but there was a need to make sure that this important price increase didn't feed into a national pricing process, says Sen

May 30, 2022 / 06:36 PM IST

Inflation has hit the Indian economy hard in recent months, forcing the government to introduce certain initiatives to fight the price rise.

On its part, the Reserve Bank of India (RBI) too has embarked on an inflation-fighting policy approach. The RBI governor recently said in an interview that inflation forecast will drive the rate action.

ALSO READ: RBI Governor interview | Expectation of a rate hike is a no-brainer, says Shaktikanta Das

Pronab Sen, former chief statistician of India, in an exclusive interview to Moneycontrol on May 30, said that the RBI has acted late in terms of dealing with inflation. Sen also spoke on a range of other issues, including the quality of data.

Edited excerpts from the interview:

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Is inflation data capturing the real extent of price rise?

The data is fairly good. The point is ― what data are you using at what point in time? So, to give you an example of two big sets of price data, one is the consumer price index (CPI). And that's what our inflation policy is targeted towards. You have an Act of Parliament, which says that RBI is mandated to keep the CPI inflation at 4 per cent +/- 2 per cent. Then, you have the other, which is the wholesale price index (WPI). Now, the WPI is in and of itself, not a target. But the wholesale price data is very important, because by and large, it tends to precede the CPI, in the sense that the CPI captures the prices only of finished consumer goods, whereas the WPI would have raw materials, intermediates, capital goods, and consumables. That’s all the inputs that are going into production. Their prices have been captured in the WPI and will show up in the CPI only when these prices finally are passed on to the consumer.

Now, the WPI has been in alarming territory since last year. The CPI wasn’t, the CPI finally picked it up later. So, in my personal opinion, the data itself has been showing exactly what's going on in the country, in the economy. RBI acted too late, it should have been thinking about inflation at least six months earlier. And then they suddenly acted now. So, I think the data is absolutely fine. And everything depends upon how you use that data. 

Then, what according to you is the government or RBI missing out in terms of dealing with inflation?

The right way to have done it is, really, for the RBI to have recognised that this is going to happen. That's where forecasting comes in. And they should have been in conversation with the finance ministry, saying that the RBI would start tightening monetary policy. And the government should cut these taxes and duties on petroleum and edible oils, and so on, which is what they've done. So, the two together would have been fairly effective in both, controlling inflation as well as making sure that growth isn't that badly impacted. There'd be some impact, but not too bad, because fiscal policy would be providing support to growth by cutting taxes.

So, where exactly is India heading towards in terms of inflation management?

The problem precedes the Russia-Ukraine war. It’s really a fallout of COVID-19 and the broken supply chains globally. So, global prices of commodities have been going up for the last year and a half, two years. It’s been going up steadily, and just for showing up in the WPI. It finally spilled over to the CPI much later. Then came the Russia-Ukraine war which just made things much worse, because Russia and Ukraine are major exporters of two very important food products ― wheat and edible oils.

As a result, global prices, food prices started going up very quickly. But prior to that, that wasn't happening in India at least. But when global prices started going up, particularly, as I said of these two, but it became a little more generalised than that because of weather conditions over the rest of the world as well, the problem became much worse.

There is an argument that inflation data lacks quality and forecast is inaccurate. What do you think could be the drawbacks India might be facing for this kind of inflation forecast?

The price rise is coming from abroad. It's coming from the global markets. But inflation is a process. It's not just a question of price rise, it's a process of prices feeding into each other. Right? That process is a local process. Yes, if global prices of petroleum and edible oil and so on go up, your prices will go up too. But that does not necessarily mean that you're in inflation.

The problem pops up is when those prices feed into other prices. Labour tries to protect its standard of living, companies try to protect their margins. That's when it becomes an inflationary process. Which is why, you had global prices going up, which is outside our control, but there was a need to make sure that this important price increase didn't feed into a national pricing process. That is where I think we fell short.

What kind of challenges could the present inflation spiral pose to growth?

In the short term, inflation actually looks very good for growth., because it lowers the effective interest rate for borrowers. So, for companies which are investing and borrowing money for investment, it lowers the costs. That looks very good for growth. The problem is that unless inflation is controlled, the uncertainty of the future becomes much higher.

You don't know what's going to happen in the future. And what typically happens is when uncertainty increases, then the first thing that happens is that investors start thinking twice before committing large amounts of money into fixed capital.

The second thing that happens is consumers. Again, because of uncertainty, they tend to save more. Both of these actions affect growth, but that happens in a little longer term. So, uncertainty in the future follows inflation rather than precedes it.

 RBI has been saying that policy actions will be dependent on inflation data. Can inaccurate estimates upset the policy path?

You have to follow forecasts when you're doing monetary policy, for the very simple reason that monetary policy works with a time lag. It's quite a long time, it can be anywhere from three quarters plus. So, you have to act relatively early, which means you have to first make a forecast of what's going to be there next year, if you don't do something now and then take a decision whether you wish to do it. Right? So that's why forecasting is extremely, extremely important.

And if we had acted earlier, maybe inflation wouldn't have reached these levels now. So, if you think about this ― inflation target of 4 percent +/- 2 per cent, that +/-2 per cent is really consciously recognising that monetary policy takes time. When inflation crosses 4 percent because by the time your monetary policy starts taking effect, inflation could have gone up to 6 percent and then would start coming down. If you wait till 6 percent and then act, then inflation is going to go up to 8-9 percent before it starts coming down.
Pushpita Dey
first published: May 30, 2022 06:36 pm
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