Useful speeches on RBI monetary framework and India inflationary trends

RBI Executive Director Deepak Mohanty has been giving excellent speeches of late.

His two recent speeches are also worth a read.

• Implementation of Monetary Policy in India 
• Inflation Dynamics in India: Issues and Concerns

Both are extension of his previous speeches.

In monetary policy implementation, he discusses the RBI monetary framework over the years and the transition from monetary targeting to multiple indicators. He says RBI’s move from money to interest rates is in line with developed economies:

Literature on the central banks’ own accounts in the industrial countries attribute five main reasons for reforms in their operating procedures during the 1980s and the 1990s.

First, monetary policy instruments were changed to adapt to the new operational frameworks of the respective monetary authorities.

Second, with financial deepening occurring more or less entirely outside the central banks’ balance sheets, the share of the financial system over which monetary authorities had direct control was reduced, warranting indirect, price-oriented as opposed to quantity-oriented instruments, ways to control the non-monetary components of liquidity in the financial system.

Third, in the wake of expansion, diversification and integration of financial markets and the narrowing of differentials between rates of return in different currencies, there was a need for instruments that could impart flexibility to liquidity management in terms of timing, magnitude and accuracy.

Fourth, the growing importance of expectations in financial markets favoured the adoption of instruments that were better suited for signalling the stance of monetary policy.

Fifth, there was a growing urge on the part of central banks to stimulate money market activity and improve monetary policy transmission while emphasising the separation of monetary and government debt management objectives.

There are two nice charts showing RBI’s monetary policy process and communication process.

In the second speech, he looks at inflation trends in India. There are some interesting aspects. He says because of globalization the domestic prices are influenced by international markets. He does some interesting analysis. He divided WPI into 4 groups. 

First, food items excluding oilseed products (weight in WPI: 24.2 per cent) : Prices of this group of commodities are largely determined by domestic factors and, in the event of supply shortage, imports influences international prices too.

Second, oilseeds and products (weight in WPI: 6.8 per cent): This relatively small commodity group has often induced sudden surge in headline WPI as there is a structural shortage and nearly a third of domestic consumption of edible oils is met from imports.

Third, mineral oils and metals (weight in WPI: 15.3 per cent): Prices of this group of commodities are largely determined by international prices and the volatility in headline WPI inflation in recent years can largely be attributed to fluctuations in the international prices.

Fourth, other commodities (weight in WPI: 53.7 per cent): These remaining commodities, largely manufactured products, constitute more than half of the WPI basket and their prices have been more stable than the other three groups.

And the findings:

Empirical evidence suggests that among the above four groups, there is transmission of prices from mineral oils and metals to the other commodities group within a quarter. The full transmissions of food prices to other commodities takes longer, almost a year. 

A comparison of domestic and global commodity price movement reveal the following. First, the direction of price movements has been similar, but the overall global commodity price movements have been more volatile, with a pronounced spike in 2007 and 2008 (Chart 2). Second, the increase in metal prices have been closely followed the global prices.  Third, domestic prices of petroleum products have been less volatile than the corresponding international prices reflecting administered prices in this group.  Fourth, increase in domestic food prices, excepting the global spike in 2007 and 2008 has been higher reflecting structural and domestic factors (Table 3).

There is also an interesting table which looks at the production-consumption gap in major food items in India. In oilseeds and pulses the consumption is higher each year from 2004-05 onwards. Another one shows that MSP continues to be revised upwards. Then per capita availability of daily food has been declining. With rise in incomes, this is putting additional pressure on inflation.

Food prices in India are primarily determined by domestic demand supply factors and domestic price policy. India meets the bulk of its large food demand through domestic production, barring few commodities like edible oils and pulses where the import dependence is about 35 per cent and 15 per cent, respectively.  In occasional shortage years, the country has also resorted to imports for wheat and sugar though it is generally an exporter in these commodities (Table 4). India’s occasional imports of such commodities translate into higher global food prices as the import demand is large. Hence, imports do not necessarily lead to domestic prices moving lower.

Table 4: Production-Consumption Gap in Major Food items in India
(million tonnes)
	Rice	Wheat	Pulses	Sugar	Oilseeds
2004-05	2.3	-4.2	-0.9	-4.1	-4.6
2005-06	6.7	-0.4	-1.0	0.7	-1.9
2006-07	6.6	2.4	-1.6	8.3	-6.2
2007-08	6.2	2.2	-2.6	5.1	-4.0
2008-09 P	6.0	9.8	-2.2	-8.1	-4.7
2009-10 P	-2.8	2.1	-2.3	-7.5	-6.0
P: Projected      (-): Indicates shortage Source: Estimated from data from Ministry of Agriculture and US Department of Agriculture

One important determinant of prices of agricultural production in India has been the minimum support price (MSP) announced by the Government for procurement of various commodities. The high increase in MSP since 2007-08 has given an upward bias to agricultural prices  (Table 5).

Table 5: Agricultural Commodities – Variations in MSP and WPI
(per cent)
Commodity		Average Annual Growth Rate
		2003-04 to 2006-07	2007-08 to 2009-10
Paddy	MSP	2.3	18.3
	WPI	2.0	10.9
Wheat	MSP	5.1	14.4
	WPI	5.5	6.7
Tur	MSP	1.7	18.0
	WPI	3.9	26.3
Moong	MSP	3.4	23.2
	WPI	11.3	13.2
MSP : Minimum Support Price WPI for 2009-10 is averaged up to February 2010 Source: Ministry of Agriculture and Office of Economic Adviser, Ministry of Commerce and Industry.

Reduced availability of foodgrains also tends to keep food prices high.  As per the Economic Survey 2009-10, per capita net availability per day of cereals and pulses has been lower than that observed in the previous four decades. The per capita daily availability of foodgrains was 447 grams in the 1960s and 1970s, which successively increased to 459 grams in the 1980s and 478 grams in the 1990s but came down to 446 grams during 2000-08 and stood still lower at 436 grams in 2008. Severe drought in major parts of the country during the current year has perceptibly worsened food availability further. In particular, the situation is far more worrisome for pulses: its per capita net availability per day has gone down from around 60-70 grams during the 1950s to around 30 grams currently.  

Excellent stuff from RBI ED. Very insightful speeches.