Since the RBI and the government do not seem to be working in tandem, the task of inflation control is not going to be easy, especially for governor Raghuram Rajan

It won’t be an exaggeration to say that the latest monetary policy review of the Reserve Bank of India (RBI) was completely dominated by the Dr Urjit Patel Committee report. The repo rate hike of 25 basis points (bps) was completely against market expectation and almost all the experts were taken aback by this move of the RBI. While acknowledging that the consumer price index (CPI) number had gone down and wholesale price index (WPI) had also fallen, the regulator went on to add, “While retail inflation measured by the CPI declined significantly on account of the anticipated disinflation in vegetable and fruit prices, it remains elevated at close to double digits. Moreover, inflation excluding food and fuel has also been high, especially in respect of services, indicative of wage pressures and other second round effects. In terms of the WPI, headline inflation eased to a four-month low with the sharp decline in vegetable and fruit prices”.
 

It is apparent that there was no serious cause of concern on inflation front whether it is CPI data or now abandoned WPI data. CPI data at double digit or close to double digit has prevailed in India for long time and policy rates have been moving and down irrespective of this. So why this new found love for reigning CPI based inflation by RBI? The answer lies in the Urjit Patel Committee report. The RBI was candid enough to accept in the monetary policy review document. It said, “The Dr Urjit Patel Committee has indicated a ‘glide path’ for disinflation that sets an objective of below 8% CPI inflation by January 2015 and below 6% CPI inflation by January 2016. The Reserve Bank’s baseline projections set out in the accompanying Review of Macroeconomic and Monetary Developments for Q3 of 2013-14 indicate that over the ensuing 12-month horizon, and with the current policy stance, there are upside risks to the central forecast of 8%. An increase in the policy rate will not only be consistent with the guidance given in the Mid-Quarter Review but also will set the economy securely on the recommended disinflationary path”.
 

It is indeed heartening to note that the Committee has set a target of 6% CPI data by January 2016 and the regulator has started working on it in a way. But will it be possible to achieve 6% CPI that sounds too good to be true. There are various factors which may make achievement of the inflation number difficult. Here are some of those factors:
 

Chicken and the egg dilemma
 

For inflation to come down, some of the contributing factors need to be controlled. For instance, minimum support price (MSP) of food grains, and other commercial crops have been increasing over the years. Will the union government support RBI by ensuring that the prices are not hiked steeply from time to time as a populist measure? Similarly, the government has substantial control on rural wages. Will it take steps to ensure that rural wages are hiked in a reasonable way? The main issue what will be controlled first, inflation or contributing factors to the inflation. While the government may think that let the inflation come down first before it initiates steps to reduce wage hikes and support price hike, RBI will expect contributing factors to the inflation to be tamed first.
 

There is also threat from private sector to the inflation. If private sector continues to see wage hike in double digit, this will further add to the woes of the regulator.
 

Fiscal profligacy arising out of populism
 

This is the main villain that makes the task of inflation control herculean. Just on Thursday, the government hiked subsidised LPG quota from nine to 12. This is expected to add a burden of Rs5,000 crore on the government. Obviously this will add to fiscal deficit. While there can be a debate on whether it is a right step or wrong one, from fiscal deficit purpose this is unhealthy. When the new government comes to power, we may see various populist measures, which will add to fiscal deficit making the job of regulator even difficult. Since the RBI and the government do not seem to be working in tandem, the task of inflation control is not going to be easy.
 

International factors
 

This is something RBI cannot control at all. Factors such as increase in crude prices and depreciation of Indian rupee due to outflow from the country is beyond the control of RBI. We have seen helplessness of the regulator when rupee fell and went to almost Rs69 level against the US dollar. In the years to come, these factors may continue to have an impact on inflation and derail the targets, which RBI is planning to achieve.
 

By hiking rates, the RBI may think that monetary policy will help curb the inflation, fact remains that monetary policy never works in isolation. While RBI may continue to keep rates hike to curb inflation, it is very much possible that the inflation remains high. It is good time to have a re-look at inflation versus rate hike trade off.
 

(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)