Questions need to be raised about the way the RBI looks at the data that forms the basis of its policy on interest rates. There are two major targets of policy: the achievement of potential growth,and low and stable inflation. The RBI has the unenviable job of balancing those objectives on behalf of the aam admi. Often,perhaps too often,I have commented upon the inappropriateness of using the wholesale price index as an indicator of inflation. Today,I will not comment on that drawback of RBI policy; but there are other problems. As we all realise,monetary policy,or any policy,has to be made on an ongoing basis. But the RBI does not do that; instead,it has the horrific habit of practicing Rear Window economics. Now that Hitchcock movie was one of the most classic of all horror movies,but that is scant justification for the RBI inflicting on India the horrors of its inadequate,and most likely wrong,policy-making.
Let me expand on this. Assume for a moment that prices were at a level of 100 (index level of 141.1) in August 2010. And then the price index went to 106 (149.5) in March 2011. In June 2011 the price index was at 108.5 (153.1) and in August 2011,the price index increased to 109.8 (154.9). So the RBI way of looking at the data is to see that inflation,August 2010 to August 2011,was at an uncomfortably high rate of 9.8 per cent. My dear,look how close it is to double-digit inflation. What we need is more rate hikes until this year-on-year number declines to our comfort zone of 4 to 6 per cent inflation.
In some months inflation is seasonally higher (or lower) than in other months (at harvest time,food prices fall,and in summer,ice prices rise) so the calculation is not as simple as above. So what most analysts,and policy-makers outside of India do is to adjust any raw data by seasonal factors to yield a seasonally adjusted series.
And when one annualises this seasonally adjusted series,one obtains a seasonally adjusted annualised rate (SAAR),which one then uses to infer underlying trends. And because of seasonal adjustments that differ from month to month,the SAAR rates will and do differ from the rough calculation given above. For example,the seasonally adjusted WPI level for March 2011 is not 149.5 but 151.4; for August,it is 153.2 versus 154.9. Thus inflation in this fiscal year is actually only at a 3 per cent rate,rather than the rough calculation of 7.2 per cent.
I apologise for this math,which is not fit for family consumption and is even less fit for digestion. But the RBI is the only central bank in the world that seemingly does not do the math,though it is high time it began to do so. In the interests of the aam admi and inclusive growth,of course.
The table documents such rates for about nine different indicators that either the RBI analyses,or should be analysing,in its conduct of monetary policy. Both the year-on-year change rates,and the SAAR,are presented. That rear window math plagues the calculations is obvious,and worrisome that such simple and wrong calculations form the basis of policy. Let us just look at the difference between the year-on-year rates and SAAR rates. Both reflect the same variable and for the same time-period. WPI inflation not 9.1 per cent,but 2.9 per cent. WPI in manufacturing,the bad guys with pricing power at their disposal not 7.2 per cent,but a paltry 1.2 per cent! CPI inflation,rural: not 8.9 per cent but 6.4 per cent,and CPI urban,not 8.4 per cent but 8.1 per cent. And both these high CPI numbers are below the high numbers of last year,so the downward trend is unmistakable.
The lacklustre,depressing and depressed industrial production and GDP growth numbers are disturbing. Note that the year-on-year numbers for both include the high growth experienced in the last six months of the previous fiscal year. But those two quarters were in the previous fiscal year and the year-on-year numbers commit the horrible mistake of double-counting. In other words,by raising rates throughout 2010,the RBI had actually acted on faster-than-normal growth. To act on them again is mistaken folly. One cannot,and should not,make policies for the future based on the performance of the distant past.
The RBI has justifiably criticised our statistical system for the amount of random noise it generates. But either the physician should heal itself or Caesars wife should be above suspicion. There is more noise generated by using year-on-year data than by CSOs incompetent reporting of data. The IIP and GDP data are a mess,and their updating methods leave a lot to be desired. But that shouldnt be an excuse for bad data to be transformed into badder policy.
The writer is chairman of Oxus Investments,an emerging market advisory and fund management firm
