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Subbarao's Lesson In Inflation

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[RBI Governor Duvvuri Subbarao had a room full of dignitaries — like a top official from the European Central Bank's statistical department, many academics from the field of statistics and economic analysts — in spilts on 17 July when he cited his receding hairline and the high rates for his hair cut to make a point on inflation. Speaking at the Sixth Annual Statistics Day Conference in Mumbai, Subbarao said he used to pay Rs 25 for a haircut 20 years ago which went up to Rs 50 even as his hair thinned. However, in recent times, though the hair growth has been almost nil, he is paying Rs 150 for a haircut. "Now when I have virtually no hair left, I pay Rs 150 for a haircut," said the bureaucrat-turned-central banker. The Governor said : "I struggle to determine how much of that is inflation, how much is the premium I am paying to the barber for the privilege of cutting the Governor's non-existing hair". On a serious note, the RBI governor said "the Reserve Bank maintains that interest cost is only one of the several factors that have dampened growth, and the increase in policy rate by the Reserve Bank alone cannot explain the investment slowdown."  (Read: <a href="http://www.businessworld.in/businessworld/businessworld/content/Policy-Rate-Alone-Not-Responsible-Slowing-Growth-Subbarao.html">Policy Rate Not Responsible For Slowing Growth</a>). "I have asked our economic research department to do a detailed study on the time-series relationship between real interest rate and investment activity. We expect to put out that report in the public domain in the next couple of months," he added. His comments come two weeks ahead of the quarterly monetary policy review which is due on July 31. Producer Price Index In order to get a a clearer picture of the price rise trend, RBI Governor also proposed a producer price index (<a href="http://www.businessworld.in/businessworld/businessworld/content/Subbarao-Pitches-Producer-Price-Index.html">Read</a> ), saying that the present structure of measuring inflation does not capture the price movement of services and is a hybrid of rate quotes. The Producer Price Index or PPI will be better able to measure the average change over time in the sale prices of domestic goods and services, he said. "In its present structure, the wholesale price index does not capture the price movement of services. Also, it is a hybrid of consumer and producer price quotes," he said. Sellers' and purchasers' prices differ because of government subsidies, sales and excise taxes, and distribution costs, Subbarao said. "For these reasons, it is, therefore, desirable that we move towards developing a Producer Price Index that measures the average change over time in the sale prices of domestic goods and services," he added. The RBI Governor also raised issues concerning data gaps with regard to computation of inflation,  national income and growth and underlined the need for rectifying them. He also questioned the linkage between deceleration in industrial growth to 6.5 per cent in 2011-12 and the increase in policy rates by 3.75 per cent by RBI during March 2010 and October 2011. "... it is necessary to look behind the data and explore what lies underneath," he added. On the current situation, the RBI Governor said, "the uncertainty surrounding economic activity has heightened in the post-crisis period. India is no exception." Core Inflation Better Than WPI-Based Inflation The RBI Governor said core inflation gives a better picture of price trends as it is less volatile than WPI-based inflation. Core inflation is usually estimated by excluding food and energy prices from the basket of goods and services that represents a household's spending. "The rationale for exclusion is that the prices of food and energy tend to fluctuate sharply and such volatility from the supply side, if passed on into the general price index, makes it difficult to interpret the overall trend," he said. "The surmise is that core inflation, being less volatile, gives a better sense of future price trends," Subbarao said. "If one takes a longer series of over three years, there is some evidence that core inflation does have statistically significant predictive power," he added. At present, apart from the WPI, India has several measures of inflation. The country also had four consumer price indices or CPIs – for Urban Non-Manual Employees, for Agricultural Labourer, for rural labourer and for industrial workers. In February this year, the government introduced a new CPI series that has the CPI rural and CPI urban, and a combined CPI that takes in both with suitable weights. Subbarao said the RBI in its annual report for 2009-10, had said that the potential output of the Indian economy may have dropped from 8.5 per cent pre-crisis to 8.0 per cent post-crisis. "Latest assessment following the standard filtering technique suggests that potential output growth may have further fallen to around 7.5 per cent," he said. "Assessing India's potential growth rate, consistent with our objective of low and stable inflation, remains a challenge," he added. (BW Online Bureau & Agencies)