Lets take this case for our study. Currently( in year 2009), India faced deficient monsoon rains. India is an agrarian economy with 50-70% of the population depending on farming or agriculture-related work. Agriculture and agriculture related work contribute to about 18% of India's GDP. Most Indian farmers live below the poverty line (earning less than $2 a day). Majority of the Indian farmers largely rely on monsoon rains for farming since there are no adequate irrigation facilities. Only very few states of India have sufficient irrigation facilities. So, with the monsoon rains failing this year (well below the normal level - around 40% less than the normal in certain states and around 26% less than normal in many other states), India has declared many districts as drought-hit districts. It is expected that this failure in monsoons will bring food-scarcity in India (India has a population of around 1.1 billion). Thus the demand for food products is about to go up, which would drive up the food prices, thereby causing inflation. The Indian Govt says that there is adequate food storage available but it has to be wait and seen to know if the storage will be really sufficient.
A special point to note here is the commodity "Sugar". India is the largest consumer of sugar in the world (remember Indian sweets :) ) and I think is the largest producer and exporter of sugar too (not sure though). But this year, with the sugarcane crops failing due to poor monsoon rains, the supply of sugar is going to go down, and hence the price of the sugar is going to shoot up (because the Indian Govt will be buying sugar in the international markets to meets its domestic demand and will hence bid up the prices due to a tight supply in sugar in international markets while the demand remains strong).
Ok, so coming to our case-study, the Reserve Bank of India(RBI) (India's Central bank) has warned the Govt of short-term(due to increase in prices of food products) to mid-term inflation(due to increase in food prices + reduced interest rates and other monetary easing) and has therefore recommended to the the Govt (basically hinted) that it would like to cut back the monetary easing and bring up the interest rates (the interest rates were brought down as a response to the global financial crisis, to increase credit flow and demand) soon before its too late.
So, what do you think about the RBI's recommendation. When I can understand that recommendation to cut back the monetary-easing stance is to reduce inflation, will this not slow down growth in the one of the fastest growing economies of the world? Will this not be counter-productive to the very poor farmers that the Govt is actually trying to help? Will this recommendation, if implemented, not be counter-productive to the growing middle-class in India (whom the world is partially depending upon to pull many economies in the world from recession)? Will this in turn not reduce the FDI flow to India which will worsen the already bad physical-infrastructure in India?
But if you say, that the interest rates should be kept low for a longer period of time, then will this not push up inflation further as the RBI had pointed out (like adding fuel to fire)?
So, what are your suggestions in this scenario that India is currently facing?
UPDATE 1 TO CASE 1 : According to the recent data released, the inflation on food products is 14.4% y/y (year-on-year) as of the week ending August 22, 2009. But a point to be noted here is that the food products were offset by a large amount last year by an increase in the global oil prices. So, I don't know if this is some number which we can rely upon. Looks like the real inflation will be much higher when we consider the broader inflation in food products on a multi-year basis. Any comments on this point?
ReplyDeleteUPDATE 2 TO CASE 1: In the recent weeks, when the food prices are keeping to soar, the Wholesale Price Index(WPI) still remains in the negative inflation category. But I can see the WPI going up, although very gradually, which is not in par with the food products inflation and i am expecting the WPI or the broader inflation to come up to the positive side in the coming months.
ReplyDeleteAnother interesting thing i would like to share, the WPI does not converge with CPI (Consumer Price Index) - wow! you might think that this might confuse the policy makers. Yes, it confuses the policy makers, especially with the 'timing' factor on some measures that are crafted BUT there is one important point to be noted - the weightage of food products in WPI measurement in 60% whereas the basket of products for CPI measurement has only 16 % food products.
Any comments on this varying weight of food products in WPI and CPI measurement? Any comments on actual variation in the value based on WPI and CPI?
UPDATE 3 TO CASE 1 : Economists are predicting a 4% - 6% overall inflation in the coming months.
ReplyDeleteO.K. So here are my suggestions to case 1 : India's food crisis:
ReplyDeleteLets consider some points concerning the current situation :
1. The Indian Govt. has introduced a fiscal stimulus package in response to the Global financial crisis.
2. This has increased the fiscal debt to around 6% of the GDP.
3. As of now, I don't think there are any "deflation" concerns. I didn't hear any economist actually saying that as a concern in Indian economy.
4. Due to increase in food prices, we have inflation concerns.
5. So to sum it up, we have Fiscal deficit + Inflation concerns.
So, coming back to the case, the RBI wanted to tighten monetary policy which was eased as a response to the global financial crisis and roll back the fiscal stimulus package.
So my analysis and suggestions are below:
Effects of monetary tightening:
1. Will cause many start-ups, heavy capital requirement industries to scale back their operations. This would in-turn lead to decline in jobs, decline in wages which would then lead to a decline in demand (which is already low compared to previous years due to global economic slowdown) and a fall in prices.
2. Point 1 actually affects poor and middle class people, who will further be affected by inevitable increase in food prices (due to poor monsoons).
3. Since interest rates would be high, more investors can be expected to invest in Rupee - the Indian currency.
4. Generally with strong rupee,foreign capital will stay in the country BUT during this economic slump, any decline in wages, decline in jobs and job creation will lead to less demand for products and there is a possibility that this might be considered to be equivalent of the country starting to face another recesssion or atleast would be thought by investors as an economic slump. So, this raises a doubt in me - will the foreign capital stay in the country, will there be a strong FDI? I do NOT think so.
Effects of prolonging the monetary-easing:
1. Inflation sure to go up ( Food prices + easy credit)
2. If there is further Govt. borrowing then this will increase the inflation further.
3. As inflations surges, the currency would become weak.
4. There is a high probability for Asset bubbles.
5. Point 3 and 4 might result in foreign capital to fly out. FDI might do down.
6. Till the bubble bursts or investors fear the currency, more jobs will be created, increasing the wages and thereby fuelling inflation further.
So, with all the above effects of monteray tightening and easing considered, here are my suggestions:
Suggestions:
1. Its good to have monetary easing for some more time(alteast say as of now, 3 to 4 quarters).
2. Govt has to bring in immediate tax reforms and these tax reforms should come into implementation from the next budget/fiscal year.
I would suggest increasing direct taxes and business taxes (from next fiscal year).
3. There should be no more Govt. borrowing.
4. Any new Govt. expenditure should be met with sale of public assets.
5. For a temporary period (say for 3 or 4 quarters), the Govt. should not open any sector further to foreign direct investment (other than what is already present). This is to make sure that no unimaginable bubbles are formed.
6. The currency has to maintained at a steady level even if inflation kicks in - so that investors don't get feared away.
So, to conclude, I would suggest to continue with the monetary easing for few more quarters and when inflation reaches a level of 5 - 7 %, lets think about monetary-tightening and the intensity of tightening.
OK just to make my point 5 (in the "suggestions" section) ckearer - I did not mean that the Govt. should NOT allow any new FDI - but I just meant that the percentage of FDI allowed in each industry(sector) should not be raised at the moment. Example would be - in Insurance sector, India allows only 26% FDI. So, I meant that this 26% should not be increased for a considerable amount of time.
ReplyDeleteUpdate 4 to Case 1 : The food price inflation was 17.47% y/y as of the week ending November 21 and as per the latest government data, the food price inflation is 19.05% y/y as of the end of last week of November.
ReplyDelete