Some Thoughts on Inflation & Monetary Policy

Q&A with Bloomberg News

Q1. Where does India stand on the growth-inflation trade-off? Do you think the central bank should now shift to a more growth-focused approach?
A1: There is no inflation-growth trade off in monetary policy at this point. Easing monetary policy will facilitate demand for consumer durables, encourage investment and facilitate recovery, without reversing the downtrend in inflation.

Q 2. With Finance Minister Jaitley now openly calling for a cut (even the technical advisory panel did in Sept.), do you think RBI should oblige and cut as early as the Dec 2 meeting?
A2: I have been arguing since September 2014 that inflation is firmly on a down trend and time for easing monetary policy has arrived. Two months later I am even more firmly of the view that Repo rate needs to be cut.

Q3. How beneficial would a rate cut at this juncture be for the Indian economy given that the decrease in oil prices is already acting as an indirect stimulus?
A3: Very. Both consume durables and non-durables show a decline in the latest availbale IIP data. Though the pass through of lower petrol price into household budgets will start having some effect on consumer non-durable demand soon, easier monetary policy is needed for reversing the decline in durables demand.

Q4. With RBI's 8% inflation estimate for Jan 2015 now expected largely to be met, do you think the 6% target for 2016 may also be undershot?
A4: According to me there is a 25% probability of CPI inflation in January 2015 itself being 6% or less, and a 51% probability of it being less than 7%. So, even though this puts RBI in a serious dilemma, I would predict that there is a more than even chance of it holding rates steady in December.

Q5. The RBI has been pointing at issues of structural inflation, especially around food. What part of these structural barriers are being addressed by the government, and which should be tackled most urgently?
A5: Inflation is down across all sub-categories, food, fuel and 'non-food, non-fuel' or core. So any talk of "urgency" is not credible. It is more important for govt not to forget the medium-long term need for agricultural policy reform to improve agricultural productivity, which is at 50% of global levels for decades.

Q6. How do you see the quality of fiscal consolidation by the Modi government? Do you think the 4.1% deficit target will be met?
A6: In my view the probability of the fiscal deficit meeting its target has gone up since it was first announced. Though the sharp fall in inflation traditionally reduces revenue growth more than expenditure growth, the reduction in oil prices will help reduce subsidies (e.g. fertilizers) and consequently total expenditures. The sharp increase in capital inflows also makes achievement of dis-investment targets easier.

Q7. What is your view on the Modi Govt's approach to reform so far...ensuring on the ground execution first rather than the big bang approach?
A7: The political economy of reforms is as important as the economics of reform. My reading of the government is that it is fully cognizant of both. Therefore it is likely to follow the approach that my reform experience suggests is the best for sustained & sustainable reform ( http://dravirmani.blogspot.in/2014/09/pm-modis-development-objectives-reform.html )

Q8. How do you see rural wages evolving in the coming months and what role will it play in the RBI's decision?
A8: Rural real wage growth rate has declined progressively over the last 12 months to around zero. There is now a danger of it becoming negative. It doesn't provide any support to RBI for retaining a tight monetary policy.
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Disclaimer: Bloomberg News designation of me as an "RBI Advisor," may be misleading. I am one of several members of the "Technical Advisory Committee on Monetary Policy(TAC)". The RBI has many such committees & groups on different issues.