And after 12 hikes in 18 months during which Reserve Bank of India (RBI) has raised policy rates by 325 basis points (or 3.25 percentage points) in its attempt to control a high and persisting inflation rate, the result is…nothing, zilch. The inflation rate seems to be sticking to the 10% mark, refusing to budge, wreaking havoc on households with EMIs and choking India’s budding consumer boom. Worse, food inflation is aflame around 9.5%, forcing the poor — all of 850 million Indian citizens who live on less than $2 a day — to sleep hungry.
The Indian citizen is being squeezed from two sides — prices and opportunities. On the former, the UPA government has perfected a policy inertia in its inability to deliver on supply-side factors that are hiking prices. The political economy of agriculture, for instance, is not allowing the government to go for reforms in the supply chain that carts food from the farmer.
By hesitating to bring amendments to the Agricultural Produce Market Committees Act, for instance, the government is only serving middlemen of the food chain, not farmers or consumers. Further, even if there are inflationary signals in the economy, say through the increase in fuel, there is nobody asking a commonsensical question: why should the prices of food, vegetables, fruit and milk increase disproportionately? The Rs3.14 increase in the price of petrol yesterday will add just 7 basis points to inflation, RBI says, but on ground numbers are remarkably different. There is market failure happening right under the nose of central and state governments and regulators and they are not doing anything about it.
A huge amount of inflation is being imported into India through the rising prices of fuel, commodities like iron ore; food prices are at their all-time high globally. But surely that's no reason why the world's second-fastest growing economy should have the world's highest inflation rate. The past 18 months have shown that there is no correlation between increased interest rates and inflation, which domestically is being driven by structural skews towards high-protein food and demand-supply mismatch in non-food commodities.
By increasing interest rates RBI has raised the cost of money in India. This was acceptable earlier when there was a 9% GDP growth expectation and inflation could be factored into that growth, as a pass-through. Not today, when growth has fallen to 7.7% from 8.8% in the first quarter of 2011-12 and factory output has fallen 3.3% in July from 8.8% in June. This means the Indian industry is coming under pressure. Part of the problem is, again, imported —Indian industry exports about two-thirds of its output to countries that are reeling under a global economic slowdown, if not outright recession.
The other part is what the world is salivating for --- India's consumer-led domestic demand story. But with interest rates rising repeatedly, this factor has weakened, the biggest expression of which is the slowdown and in some cases a contraction in sales of cars and bikes. But RBI is unrelenting: "A premature change in the policy stance could harden inflationary expectations," it said.
What does that mean? Interest rates will continue to rise. So, growth will slow down --- and with it jobs and raises. But inflation will not fall.