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See deflation ahead, RBI can't do much: S&P

See deflation ahead, RBI can't do much: S&P

Inflation for the week-ended March 7 came in at a historic low of 0.44 per cent.

Inflation for the week-ended March 7 came in at a historic low of 0.44 per cent week-on-week (WoW) compared to 2.43 per cent.

Subir Gokarn, Chief Economist – Asia Pacific, Standard & Poor’s (S&P), said the inflation number reflects the significant decline in prices of energy and several commodities over the last one year. “We should expect this number to actually go into negative territory as the accumulative effects of all these commodity price declines flow through the system,” he said.

On possible Reserve Bank of India (RBI) action, Gokarn said, “The recognition now is that you’ve done a lot in terms of increasing liquidity in the system. But that liquidity is simply not getting passed on to where it would do the most good, which is into the hands of consumers and companies, who borrow for legitimate consumption and investment decisions or actions.”

“It is now a situation of maybe minor cuts to send a signal that the policy is still in motion. But [there should be] much greater emphasis on finding ways on getting banks to lend through productive channels and not have it just parked,” he said. “It doesn’t matter the government borrowing as long as the government is actually using this money to spend on the things that will spur demand.”

Here is a verbatim transcript of Subir Gokarn’s exclusive interview on CNBC-TV18.

Q: Are we headed towards a deflationary environment or is this number a statistical quirk?

A: It is a number that reflects the very significant decline in prices of energy and several commodities over the last one year. Remember this is a year-on-year number and as a result of that the costs of production of many manufactured items, many primary articles have also come down compared to what they were last year. So the combine effect of this is to bring the value of the index to a level, which is barely above what it was last year. Of course, in between we had a lot of rising and over the next few weeks, we should expect this number to actually go into negative territory as the accumulative effects of all these commodity price declines flow through the system.

But we have to be clear on what deflation actually means and why it is significant from a macro-economic perspective. Let me give you a very brief description of the process. Deflation is a problem when people perceive prices to be falling at a rate which makes sense for them to postpone consumption to postpone buying decisions. So if they see prices falling week-on-week, they say well let’s wait for a week, let prices come down, we’ll buy then and if enough people postpone buying decisions, that impacts on production decisions, that impacts on inventory accumulation and that’s sets in motion a negative production spiral.

So that’s the fear that people have. The second process – that companies find the price of their products falling but they are not able to bring their cost down because they have tied themselves into labour contracts and wage contracts, which they cannot change overnight. So as prices of products fall, margins tend to shrink and that would bring companies under pressure. That is another negative aspect of deflation.

I don’t think, with this number, or even the numbers that are going to come over the next few weeks, which may be negative territory year-on-year (YoY), we are actually in that situation. So while statistically or technically it is correct to say it is deflation, I don’t think the macro-economic consequences of deflation has we know them are really on the table in this situation.

Q: The other point is about consumer price index (CPI) versus wholesale price index (WPI). The CPI does not come down. The WPI that we keep watching keeps sliding. Food price inflation is still high. How do you reconcile the two?

A: One thing is that the CPI is one month behind the WPI. The WPI comes out every week with a two-week lag. The CPI comes out once a month with a one- or two-month lag. So, the CPI number that we see actually reflects price conditions in January. We had a number of disruptions in January. I suppose there were some crops that were disrupted. But I remember that onion prices were particularly elevated in January. We had the transport strike and so on.

So, these are disruptions that have driven food prices up and are now really capturing the effect of these disruptions in the index. The WPI food price numbers are also a little bit high. That suggests that these supply disruptions are still in play but not that significant.

From a consumer perspective, if you are looking at deflation from the buying decision viewpoint, which is the consumer saying I will wait till next month or next week to buy because I know prices are going down, obviously the CPI becomes the more relevant measure. We are not seeing the CPI levels going down into negative inflation rates. Obviously that process cannot be initiated. People are still saying I’d rather buy today than tomorrow because I think that prices may still go up tomorrow.

Q: What do you expect the Reserve Bank of India (RBI) to do? Do you expect quick monetary action coming in?

A: The recognition now is that you’ve done a lot in terms of increasing liquidity in the system. But that liquidity is simply not getting passed on to where it would do the most good, which is into the hands of consumers and companies, who borrow for legitimate consumption and investment decisions or actions.

That is getting parked in treasury bills and government securities and in the reverse repo window. The money is being used for something obviously. But it is not being used for things that will help the economy to recover. So, I think the emphasis on the monetary front, and obviously we are seeing similar kinds of reorientation of monetary policy in countries that have brought interest rates down to zero, the US and Japan talk of quantitative easing but that is a different way of saying we have gone as far as we can go on interest rates and we have got to find ways of getting more money flowing through the system.

Our challenge in that sense is similar that as much liquidity as there is in the system, unless a much greater percentage of it goes into productive channels, the impact of further rate cuts by the RBI is going to be limited. So, there is no point in using up their ammunition to do something that may not have an effect now and run out of it when there is a prospect that would be more effective a little bit in the future.

So, I think it is now a situation of maybe minor cuts to send a signal that the policy is still in motion. But [there should be] much greater emphasis on finding ways on getting banks to lend through productive channels and not have it just parked. It doesn’t matter the government borrowing as long as the government is actually using this money to spend on the things that will spur demand. But at the end of the day, that is really the blockage or constraint as far as transmission of policy into economic recovery.
first published:March 20, 2009, 12:37 IST