RBI: Fighting inflation or fighting the poor?
The RBI has kept interest rates on hold citing high inflation. This hurts the lower income population. Do we realize it?
The RBI has kept interest rates on hold, citing high inflation. According to the RBI, growth is robust. It is the RBI’s mandate to keep them between 2-6%, with 4% inflation as a designated target. India's retail inflation accelerated to a 9-month high of 5.49 per cent on an annual basis in September, driven by a persistent rise in vegetable prices and a lower year-ago base. So, the RBI’s actions seem logical. Yet, the reality is not so simple.
Inflation and Expense basket
Inflation (i.e. consumer price inflation) is also the rise in prices of the expense basket of the population. The expense basket is pre-decided based on minimum food requirements, basic services, other products, etc. Weights are attached to the products based on the proportion of consumption. Prices for such a weighted basket are watched closely. Inflation is the change in the price of this basket.
But, just as we have an expense basket, do we have an income basket? The income basket (as a corollary to the expense basket) will be a set of products from which a particular income class derives its income. The income and expense baskets overlap significantly in the lowest-income classes. In other words, the lowest-income classes derive their income from products in the inflation basket. So the expense basket of the economy, i.e. our inflation basket, is the income basket of the poor!
This raises a far more important question - are these people poor just because their incomes are watched and controlled? One can anecdotally refer to farm incomes.
Further, some commodities in the expense basket have more bargaining power, like oil or gasoline. The prices of these items are set externally and cannot be controlled. It depends on whether Iran is going to attack the US or Israel; or Russia is going to attack Ukraine, or such other factors. If this happens, inflation rises to very high levels.
When Inflation rises.
The RBI rushes in like a saviour. It will use every force and every tool at its disposal to strangle and choke the prices of the expense basket so that they rise no more than 4%.
And what of those whose incomes and livelihoods are derived from the products in that inflation basket? They will, therefore, be strangled, choked by the RBI's vice-like grip. They and their future are the necessary sacrifice or maybe a convenient sacrifice to appease the inflation gods. And these analysts will cheer the RBI, sitting in their cosy air-conditioned offices, for they are the high priests in the temples of Inflation gods.
In Sum
Conventional wisdom says that inflation hurts the poor more. Yes, it is true, but only when the source of the inflation is outside their income basket.
When the RBI tolerates explanation, we get various side effects.
When the RBI tolerates general inflation (in both in food and non-food components), it leaves the poor slightly poorer. If they can raise productivity, they will end up without a loss. If they are lucky, they will even have marginal improvements in their wealth. [Not counting the land price inflation].
When the RBI targets general inflation (in both food and non-food components), it hurts agriculture-dependent people but relieves the non-agricultural population.
When the RBI targets food inflation when there is no non-food inflation, it hurts everyone—and it hurts the poor agri-dependent workforce a lot more. This is today’s scenario.
So, we need to re-examine our framework and reconsider targeting food inflation.
In the next post, I will explain how this idiotic pursuit of low inflation deflates animal spirits and subdues growth. Subscribe now to receive it in your inbox.
