Ashima Goyal,who is a member of the Technical Advisory Committee on monetary policy since its inception in 2011 and a Professor of Economics at the Indira Gandhi Institute for Development Research (IGIDR), says headline inflation will slow from the present level as food prices are going to come down. She spoke toManojit Saha. Edited excerpts:
Do you think retail inflation, which has risen to above 6 per cent in July mainly due to rise in food prices, can derail Reserve Bank of India’s 5 per cent inflation target for March 2017?
We are in a special situation as the country has seen a poor monsoon in the past two years. Despite that food inflation did not reach high double digits like in the late 2000s.
The government has taken some steps to increase the acreage of food items like pulses. Monsoon is good this year. We could see a fall in food prices going ahead.
Last time when we saw double digit food inflation, it had an impact on inflation expectations. Also, with increasing government expenditure, the rural wages were rising very fast. That led to the persistence of food inflation since food demand went up but supply side bottlenecks had not been resolved. But this time, we have seen some action on the supply side. Also we do not currently have that kind of high rural wage growth. Some select items like vegetables are seeing double digit growth but that is likely to be temporary. And, that is not going to impact expectations. Overall food inflation has not reached double digits. So, this time retail inflation is not likely to be persistent.
Even if the 5 per cent target is breached, RBI will remain well within the overall target of 4 per cent, plus or minus 2 per cent.
But inflation expectations are still high?
Household inflation expectations were in double digits but fell steeply. Then there was a slight uptick. If food prices fall after the good monsoon, then expectations will also fall. Also, it is the direction of this expectation which is important than the amount since that is subjective.
In addition, inflation targeting plays a role in anchoring inflation expectations once the average household thinks inflation is going to come down and stay at 4 per cent.
What do you think must be the two key priorities of the new RBI Governor Urjit Patel?
He has to resolve the bank NPA issue yet get credit flowing. I think some combination of discipline as well as allowing them some time so that they can benefit from the business cycle turning to that of lower rates and higher growth.
Second, since he was the author of the inflation targeting framework report, to help set it going will be an important priority. Using signals to anchor inflation expectations even as growth revives and rates fall could be a challenging and interesting task.
Inflation targeting does not mean only raising rates — if inflation is falling, the repo rate needs to fall. And if you don’t reduce the rate if inflation falls, it hurts inflation targeting itself. People say if you are an inflation hawk you will keep rates high.
But rates are dependent on inflation. If inflation falls, interest rates have to fall. That inflation targeting does not only mean increasing rates also has to be communicated.
There is a debate about targeting headline inflation as some say we need to be flexible. What are your views on this issue?
If the premier role of inflation targeting is to anchor household inflation expectations then the headline CPI basket has the prices they see. That is why it is useful to target the headline CPI.But it is true that the headline has a lot of components that are not affected by aggregate demand. So, RBI’s actions alone are not going to reduce that inflation except to the extent that it stems inflation expectations.
I think we should target CPI but there is a need for more coordination between the government and the RBI in terms of what components of inflation that the government can best address through supply side management, improving agriculture infrastructure and marketing.
Do you think the medium-term inflation target of 4 per cent is achievable?
As I said the cooperation between the demand and the supply side, between the RBI and the government is very important to achieve this. If prices of some critical commodities like oil, food, pulses, milk are brought down, in which the government has an important role to play, the target is achievable.
RBI talks about maintaining a real rate of interest of between 225 and 250 bps, which is the difference between inflation and the repo rate. Do you think there is a need to revisit the real or the neutral rate?
Internationally, there is a huge debate on this. People are saying that neutral or natural interest rate is in negative zone due to demand recession. In India, we also have a lot of excess capacity, export growth has been falling, which means we are facing a demand shock from abroad. The neutral rate is affected by temporary shocks. Negative demand shocks reduce it. The natural rate cannot be a fixed rate. It is subject to present conditions. Policymakers have to respond to demand shocks. The natural rate can be 1 or 1.5 per cent depending on the situation. Since domestic demand is also low, the policy needs to compensate for that in order to stabilise output. So, probably the natural rate is lower than 2.5 per cent.
There is a concern that GST, which is expected to come into effect from April 2017, will stoke inflation, at least in the short-run. Will that be a concern for policy makers?
If it is a temporary blip then there is no need to worry. I think any rise would be a transient issue. In case if it coincides with falling food prices, and oil prices remain soft, and so that headline inflation stays well within the target band of 4 per cent +/-2 per cent also, it would not be an issue.
Economic growth continues to be sluggish. What are the constraints?
One puzzling factor is the persistence of low private investment. That is required for growth to pull up. It suggests demand is the real constraint. Firms will not invest if they don’t see movement in sales.
There are also sectoral issues such as the high debt of infrastructure developers because projects were stuck. The payouts following the Seventh Pay Commission implementation should help revive consumer demand.
