Neelkanth Mishra, Co-head of Asia Pacific Strategy, India Equity Strategist with Credit Suisse and part-time member of the PM’s Economic Advisory Council, unpacks the inflation basket. This explained.Live session was moderated by Anil Sasi, National Business Editor
Neelkanth Mishra, Co-head of Asia Pacific Strategy, India Equity Strategist with Credit Suisse and part-time member of the PM’s Economic Advisory Council
As economies have opened up, supply is responding but demand had gone up well in advance. That created inflation exacerbated by what we call supply chain bullwhips. When there is a slight amount of shortage, everyone moves from “just in time” to “just in case.” Instead of having enough inventory, you start saying, “I don’t want to lose production, so let me order some more.” The apparent demand starts to move up much faster than real demand. Everyone is building an inventory. In the US in particular, this became really bad because it didn’t have the manufacturing capacity to meet the additional demand, but it had triggered that demand by handing over cash to people through a stimulus. The demand went over to China, Japan, India, Bangladesh and when the goods started hitting the US ports, they realised these didn’t have the capacity. This triggered a wage-price spiral in the US, which is the most dangerous form of inflation where people start demanding wage hikes and prices go up.
In February 2022, when the Russia-Ukraine conflict started, the global oil supply went down, exacerbating inflation. Dense energy is critical for economic growth and if there is a shortage of gas and oil, the global GDP has to shrink by that much. Now for that to happen, demand has to fall, and for demand to fall, prices have to go up. I think this is a very serious problem. Fiscal and monetary interventions are being undertaken by most countries which can afford to subsidise oil prices. Everyone, from Australia to the US and China, is giving incentives. They have cut down excise duties so that the retail price of oil doesn’t change. But the suppliers benefitting from this are unwilling to invest in increasing capacity because they’re unsure how long this will last. Then there is what I would call forced saving. If the global oil market was $ 2.5 trillion at $ 70 a barrel, it is now closer to $ 4 trillion, so $ 1.5 trillion is moving from consumers to suppliers. The consumers are buying less and the suppliers are saving the surplus. This is a forced saving which is very bad for growth and leads to stagflation. I don’t think this is going away in a hurry.
On CPI inflation converging towards wholesale inflation
Whether rate hikes are the right solution is debatable. We tend to look at inflation on a year-on-year basis. We need to look at how inflation impulses have been coming through month-on-month changes, if they are below or above seasonal. The CPI inflation went up from 4.3 per cent in September last year to 7.8 per cent in April, because of the seasonal moves in the index. The October-November moves were almost 100 per cent in vegetables as prices went up sharply. While there was correction in onion prices, tomatoes and potatoes became costlier.
The March-April inflation was global because of higher prices of crude oil. Cereal inflation went up mostly because of global wheat and our free grain scheme, the Pradhan Mantri Gareeb Kalyan Ann Yojana, caused rice and wheat prices to fall. So, there are several one-offs in that local component. When you raise rates, you are slowing the economy down to match demand and supply. That is debatable.
On the variation in Central bank interventions
The biggest problem for India is our significant dependence on imported energy, which is four per cent of our GDP. So, if prices go up by 50 to 60 per cent, you see a natural outflow of nearly two per cent of GDP. It’s simplistic, but say everything remains the same and prices go up by 2.5 per cent, is it necessary to raise rates to control that price? Our challenge is the need to curtail demand and our biggest problem is our balance of payments. We were running a reasonably comfortable balance of payment surplus of about $15 to 20 billion on an annual level. If your imported energy bill goes up by $90 billion and there are commensurate increases in coal, gas, fertiliser and edible oil, because all of them at some level are linked, your balance of payments is suddenly in a $70 billion deficit.
Now you can keep paying for it by increasing capital flows but you need to reduce your imports. Before the Russia-Ukraine war, my view was we would report a GDP growth of 3 to 4 per cent in FY23. That number has to be brought down because there’s almost a 2.5 per cent extra burden of energy cost. We need to frame monetary policy based on our needs, not follow the US Fed.Anil Sasi, National Business Editor
On the RBI’s role
There are multiple aspects here. In my view the most reliable unemployment indicator is the NREGA job demand. If two crore people are wanting to work at Rs 200 a day, that’s an important indicator of the slack in the economy. That number is now only about 20 lakh higher than the average in April 2019, which I think is an important indicator of normalisation.
But the question is which tool do you use? There is a repo rate, the rate at which banks borrow from the Reserve Bank, and there is a reverse repo rate, so that banks can deposit surplus funds to the Central bank. When there is significant overnight liquidity, too much money in the system and banks are unable to lend it, they deposit funds with the Central bank. When you have this kind of surplus, the effective rate is the reverse repo rate, not the repo rate, and it has gone up. For the fortnight ending September 2021, the cost of absorption, the effective reverse repo rate, was 3.37 per cent, and in February it became 3.87 per cent because the RBI started to absorb liquidity through what they call the VRRR, variable rate reverse repo auctions.
The wage-price spiral in the US is not visible here. Most vegetable prices are local and till the time we see local wage rates go up significantly, there is a lesser need to tighten because of the risk of entrenched inflation expectations. This is something we need to watch.
I think the inflation expectations are more anchored to the Consumer Price Index (CPI). The Wholesale Price Index (WPI) is what companies see and it’s much more influenced by crude and commodities. If inflation expectations start getting entrenched, then we need to worry more.
On the signals from RBI
I think the off-cycle hike was to a large extent influenced by the Fed’s increase, because when we think about capital flows, we tend to think of it as portfolio investors, as foreign direct investment, venture capital, private equity and external commercial borrowing. A very reasonable part of our dollar inflows is actually trade financing. What happens is that if the Fed hikes and you don’t –and these are all very short-term loans – it makes much more sense on a currency arbitrage basis because the US rates are always lower than ours.
There is a risk of the rupee depreciating, which is why those rates are stabilising at a certain gap now. If that gap widens, it makes sense for the new borrower to repay the dollar debt and borrow in rupees. That increases the demand for dollars. If you raise rates, you get more dollar inflows but that is not really true in India. If you see our capital inflows, most are related to growth. So, for indirect investment, venture capital, private equity, portfolio investment in equities, we don’t have rate-linked flows.
In any case, there was some normalisation that was necessary given that the economy is reviving, so some rate hikes will happen and should happen. We need to check if the Fed keeps hiking on the very short-term flows. If we are not careful, we could see a much sharper dollar outflow than we have seen so far, which can then pressure the currency.