No end to central bank’s woes


Two critical data points, released last week, on the face of it make the Indian central bank’s job less difficult than what it has been so far. The wholesale price inflation for October at 7.45% is the lowest since February, much lower than market expectations of 7.9% and September’s 7.81%. What more, the non-food, non-fuel or the so-called core inflation in October dropped to 5.17%, its lowest since May, and down from 5.56% in September.
This, along with a 0.4% contraction in factory output in September compared with a 2.3% growth in August should logically encourage the Reserve Bank of India (RBI) to go for a policy rate cut as inflation is coming down and one does not need any more evidence to prove that growth is slowing in Asia’s third largest economy. India’s gross domestic product (GDP) grew at 5.5% in the first quarter of the current fiscal after registering a nine-year low 5.3% growth in January-March and, if industrial growth is any indication, one is not sure whether the 5.5% GDP growth can be sustained in the second quarter. In the first half of the fiscal, industrial output growth has been just 0.15%, sharply down from 5.1% in the first half of the last fiscal.
Ideally, this data should end RBI governor D. Subbarao’s dilemma on the growth-inflation dynamics, but if one takes a closer look, things are not that simple. The key contributing factor to the drop in wholesale price inflation was 2.2% contraction in the vegetables and food index, as a result of which food inflation dropped 1.25 percentage points from September. There was no change in the fuel and power index and the reasons behind softening of the core inflation were a drop in global commodity prices and appreciation in the value of rupee that brought down the cost of imports.
Nobody knows whether these two factors will remain unchanged. The flood of global liquidity may push up the cost of commodities and the Indian currency has already surrendered most of its gains against the dollar. The local unit, which dropped to its lifetime low of 57.15 against the dollar in June, rose to 51.75 in the first week of October after the Indian government announced a series of reform measures, including opening up of retail and aviation for foreign investments. On Friday, the rupee closed at 55.18 to a dollar.
The other worrying factor is that the August inflation figure has been revised sharply from 7.55% provisional estimate to 8.1%. So, there is no guarantee that the October inflation figure would not be revised close to 8%. Also, at 7.63%, the average inflation in the first seven months of the fiscal is much beyond RBI’s comfort level.
Yet another discomfort for the central bank is high retail inflation, which rose marginally to 9.75% in October from 9.73% in September. Retail inflation in urban India eased in October to 9.46% from 9.72% in September but in rural India it rose from 9.79% to 9.98%. RBI, which had traditionally been focusing on wholesale inflation and particularly core inflation, now keeps a close tab on retail inflation while making its policy decisions.
As if sticky inflation and contraction in factory output are not enough, a record trade deficit is adding to the macroeconomic woes and making the task of the central bank much more difficult. India’s exports fell in October—the sixth month in a row—with shipments declining 1.6% to $23.25 billion in the year-ago period on account of slowing demand in developed markets. But imports rose by 7.4% to $44.2 billion, primarily because of higher oil prices and rise in gold imports. As a result, the trade deficit in October widened to a record $21 billion. In the first seven months of the fiscal, exports shrank 6.2% but imports contracted only 2.7%, leading to a trade deficit of $110.2 billion. At this point, nobody is sure to what extent India’s current account deficit will be lower than last year’s record high of 4.2% of GDP.
Along with widening current account deficit, a rise in the fiscal deficit—beyond the government’s revised estimate of 5.3%—will be no surprise. A lukewarm response to the telecom spectrum auction makes it clear that the government will fall short of its revenue target even though it is hopeful of raising Rs.40,000 crore from the sale of second-generation spectrum sale and another Rs.30,000 from share sale in public sector units. It has not sold its stake in any company so far. High inflation, higher than estimated fiscal deficit, low growth and concerns on twin deficits will continue to haunt RBI, even though it has committed to cut the policy rate in January.
Gokarn’s successor
A search committee is on the lookout for RBI deputy governor Subir Gokarn’s successor. It held one meeting last week and is meeting again on Monday. Gokarn’s last day in office is 23 November. He came to Mint Road in 2009 with a three-year term. I hear that the constitution of a search committee does not automatically disqualify Gokarn for another term. If the committee is convinced, he can get another stint at RBI, or someone else could replace him. There is nothing wrong in forming a search committee to identify a suitable deputy governor, but why does the government have to wake up so late for such a critical appointment? The committee was constituted roughly three weeks before Gokarn’s term ends. Will it be able to complete the process before 23 November? If indeed a new person is chosen, it will take a while to complete all formalities. And even if Gokarn is chosen for reappointment, there will probably be a gap between his last day at RBI and beginning of a new tenure if they follow all formalities. It’s just not funny.

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