Based on the consumer price index data, Ajay Shah, senior fellow of the NIPFP, believes that it‘s not a good time for the RBI to be cutting rates.
Based on the consumer price index data, Ajay Shah, senior fellow of the NIPFP, believes that it’s not a good time for the RBI to be cutting rates. “India still has a serious inflation crisis, so I was a little surprised when I saw the information yesterday,” he said.
In an exclusive interview to CNBC-TV18, Shah said the government should look at the CPI to determine local inflation, not the WPI. “The WPI is not a very useful inflation measure. Nobody eats nickel, nobody eats steel and these are components of the WPI. So the WPI is a useful price database, it is not a price index to take seriously,” he explained. According to him, the RBI should focus on food, services and wage inflation, which is what is effectuated by the credit policy.
Shah goes on to say that the major problem is with investments, but in the public sector space. “In everything that is connected with the government, there is a collapse in investment and that’s not something that interest rates can do anything about,” he said.
Going forward, Shah sees inflation remaining around 9%.
Below is an edited transcript of his interview with Latha Venkatesh and Ekta Batra. Also watch the accompanying video.
Q: What’s your own comment on the higher than expected 50 bps repo cut that the governor gave us? Has he been unnecessarily aggressive and adventurous you think?
A: I was surprised. I have been closely watching the inflation data. We had three good months of CPI inflation in terms of the month-on-month seasonally adjusted change. Then we have had two latest data points at 8% and 12%. These are annualized rates of the month-on-month change, and that’s actually not a very comforting environment. This is pretty much back to our normal inflation crisis environment, it’s not a good time in which to be cutting rates, so I was a little surprised when I saw the information yesterday.
Q: Do you think that this will now start reflecting in the WPI (Wholesale Price Index) as well? Do you believe that that 6.5% is attainable especially if some of the administered prices are passed on?
A: Well, the WPI is not a very useful inflation measure. Nobody eats nickel, nobody eats steel and these are components of the WPI. So the WPI is a useful price database, it is not a price index to take seriously.
A lot of the WPI is tradable, so the WPI tends to reflect exchange rates and international market prices. It does not reflect precisely what matters for monetary policy, which is local inflation, domestic inflation, non-tradables inflation. That’s what monetary policy within India can address.
So the elements of inflation which should be the main focus of monetary policy are those that are understated in the WPI. So I would really not take the WPI too seriously when thinking about monetary policy in India.
Q: RBI’s main argument has been that we should look at core inflation, not even at the non-tradable part of the WPI that is food, because that is all we can influence with interest rates. You don’t buy that argument at all; you believe that Reserve Bank should be looking at the non-core elements as its main focus of attention?
A: WPI minus food minus fuel is almost all tradable. So if I want a poor man’s price index for tradables in India I use WPI non-food, non-fuel. That is the stuff which is out of the control of the central bank. It is world prices and the exchange rates, neither of which the central bank can do anything about.
What the central bank should be focusing on is everything else, which is essentially the bulk of CPI, such as non-tradables, services, wage inflation and food. These are the things that domestic monetary policy can do something about.
Q: If there is a possible rate cut which could come now post this 50 bps, what is going to lead the RBI to do that?
A: I think reasonable men will agree today that India has a serious inflation crisis. For every single month after February 2006, the year-on-year CPI has been above 5% and that’s really not a pleasant state of affairs. Where there is room for disagreement is about how the economy is faring.
I read the 50 bps cut of yesterday as tantamount to saying that RBI believes we are at the edge of real trouble, that there is a dramatic collapse on the output side that is coming and you need to desperately shore up demand.
That’s not my reading of the data. Let’s look at a couple of the pieces that are visible. You have to start with the IIP, which is not something that anybody wants to take very seriously, but even if you do take the IIP seriously, the month-on-month seasonally adjusted performance of the IIP in recent months has been excellent. There is nothing to complain about because there is clear double-digit rate of growth. Many other output indicators are actually doing rather well.
Most important of all is that the nominal sales growth of all listed companies for the October, November, December quarter year is 22-23% nominal. Even if you think inflation is around 10%, it’s like 12-13% real. So I am not convinced that we are at the abyss, I am not convinced there is a collapse of output which is just around the corner, I am not convinced that there is a serious problem in investment.
Where there is a serious problem is in the investment projects that are connected with government, but that has to do with governance problems. If you look at manufacturing new project starts in the CMI database, the latest data point which is for Jan, Feb, March 2012 is just bang on the long period median. Now that’s not great, but it’s not in a state of crisis either. It is in everything that is connected with the government that there is a collapse in investment and that’s not something that interest rates can do anything about.
Q: I take your point on your corporate data, but IIP Jan reading was 1.8% or something. Feb was about 1.6% or something, where you said double digits?
A: That’s the average of 12 months. The first health and safety warning that all of us should be putting on is please do not use the IIP. All of you in the media have an obligation to tell all your viewers, do not listen to the IIP. If you do want to listen to the IIP the latest five months of the month-on-month seasonally adjusted IIP is actually nice. It’s in double digit terrain.
Q: Why do you say that? Like in the early 1990s, do you think the trigger for reform would actually come from the external front where the current account deficit is already at 4.3%?
A: There are two key differences compared to the 1990s. The first is that we have a flexible exchange rate. I know that in recent months RBI has come back to intervening, and I think that’s not a very wise thing, but I feel that for all practical purposes the exchange rate will move. When there is real stress, RBI will get out of the way and the exchange rate will move. So we have one great stabilizer in our midst; when times are bad the exchange rate will depreciate and that will help to protect the economy. So I think that’s one great source of stability that we have now obtained.
The second is our debt of engagement with financial globalization is really transformed. In the early 1990s we had completely shut ourselves off from the world. Today, on the equity market, in the world of private equity, in the world of borrowing by the large Indian companies we are now well connected with the globe. So as long as Indian asset prices go down, there will be attractive buying opportunities and foreigners will buy those assets which will generate the capital flows which will keep this economy going.
Q: Yesterday there was a lot of debate with regards to the RBI being convinced to the 50 bps cut because the Finance Minister almost gave it away 30 minutes before the policy. Your perspective on a bit of the softer issue on this in particular?
A: I don’t have a judgement about how this works.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.