India is not ready for CPI Based inflation targeting – not yet

It has been close to two years since the Urjit Patel Committee Report set the CPI based inflation ‘Targetting’ as the primary axis of our monetary policy. There are murmurs now from both the Vice Chairman of Niti Aayog and the CEA. In both its key thrusts (i) abandoning the multiple indicator approach for inflation control and (ii) adopting CPI combined instead of WPI as the inflation to target, it is looking like a cricket umpire trying to control the football game in the adjacent ground. With the benefit of hindsight, it looks out of context and tautological in its key arguments and conclusions.

Inflation targeting

“Anchored inflation expectations will … provide the latitude to address other objectives without compromising price stability” (Para II.3). In 18 months RBI has not been able to even ‘anchor’ interest rate expectations – there is so much of debate before each meeting and annoyance after. To anchor inflation expectation by stabilizing inflation to provide a stable interest rate regime to create ideal conditions for investments to generate employment and growth … by the time this comes about it may be Saturday in the Economic Solomon Grundy’s life cycle.

‘High inflation expectations exhibit far greater stickiness than inflation (para 3.2).’ In the past 5-6 years most of inflation has come from agricultural commodities and fuel – segments least under RBI’s control. Our agricultural markets are the most ‘perfect’ markets and given Indians’ mindset of ‘bargain everything’, prices quickly readjust to imbalances. If the Onion prices ruled at Rs 80 one week and slid to Rs 20 the next 2 weeks it is inconceivable that anyone’s expectation will be guided by the Onion prices that prevailed 3 weeks ago. The reverse is also true. Trying to stabilize them through interest rates is a fruitless exercise.

The level of emphasis to be given to inflation control should ideally depend on the national ‘wealth to current income’ ratio. Where it is high and more citizens depend on interest from savings for livelihood, preservation of money’s value is more important. India’s ratio will be dismal comparatively and hence there was a need to balance it with growth and employment objectives. In our context jobs are the best social security.

Constraining Targets

The targets set are a source of worry, for growth itself can cause inflation. For example, in a 2 product, 2 player economy producing 4 coconuts and 2 fish, each fish will retail for 2 coconuts. If the productivity of coconuts increases to 6, the price of fish will become 3. In a monetized economy, wages are terribly sticky downwards and the price of coconuts (derived from the wages which do not move downwards) will remain the same and the price of fish will move up by 50%. There will be the inevitable inflation even if the weights are corrected. This is harmless inflation however. Suppressing this will only result in curbing growth.

A constant inflation target of 6% (+/- 2%) irrespective of whether the growth is 4.5% or 8% seems meaningless.Given India’s rigidities and the way minimum wages are revised whimsically, a 6% target may be far too constraining for a 8% growth target.

In a place like Singapore where trade credits are near totally from banking system, and firms are leveraged 3 or 4 times and work on thin net margins of 2 percent, a ¼ % is a huge dampener and firms might start cutting down on stocks from the next cycle itself. In India with 10-12% gross retail margins a large proportion of which is imputed labour and imputed rent – both far less sensitive to interest rates – and credit largely accessed from non-banking sources, a ¼ % interest rate adjustment to tame or stoke inflation seems irrelevant. Large dosages to achieve a given reduction in overall inflation will hurt a whole host of other sectors disproportionately.

Pitfalls of a statistical approach

The report relies on the New Keynesian Philips Curve equation as the theoretical framework. The 3 factors listed (output gap, cost push, and expectations) in the supply block of equation while relevant is far from decisive or comprehensive. Let’s see an example – how ‘cost push’ can be highly episodic or fickle.

The supply curve is the marginal costs of various firms stacked in increasing order from most efficient to most inefficient and the price is determined purely by the marginal cost of the most inefficient firm required to fulfill a given level of demand. The cost structure of all the other more efficient firms stand irrelevant. Where the most marginal supplier unit (which determines the price) happens to be an overseas firm, prices will be purely determined by import parity. Domestic cost structures do not matter at all: what will matter is the cost structure of source countries. In such a case currency movements play a much larger role.

Again, where the marginal cost difference between the least competitive firm and the next is low or negligible, output gaps may not have an impact on inflation at all.

One does not know how one can form firm action-effect inflation targeting policies on such highly fickle variables alone.

Flawed assumption

The report justifies targeting since ‘persistent inflation worsens income distribution as the poor carry greater proportion of cash’(II.1). This is spurious sympathy. Poor carry cash largely for transaction demand. In rural areas savings till the next season is largely in grains and savings over longer term is in Gold. Surplus cash in the informal sector finds its way largely into small unorganized chit funds and informal credits earning 5-6% per month. It is impossible to conceive that they carry cash over longer time as savings. A cash balance of 2 months when inflation is 12% per annum suffers 2% value dilution. This is just 1% higher than at the targeted inflation levels – hardly relevant which only shows a lack of contextual knowledge.

Inflation in a way represents existence of consumer surplus. In the initial wave, it’s only products with high consumer surplus that will move up in price. There is no reason for RBI to be an arbiter in such a case. It is only in the secondary waves prices of others will move up before it becomes a monetary phenomenon. If those affected in secondary wave are interest rate sensitive then to target inflation with interest rates becomes logical: but only if.

Any regulator will have to keep the aspirations of the people in mind. Ask any job seeker whether he would prefer a job or live with an additional 5-6% inflation. Employment will most certainly be preferable to preservation of value. Growth expands employment opportunities. To be dismissive of these almost mockingly and concentrate on CPI based inflation is to forget the context.

One wishes the Committee had taken advantage of recent advances in Behavioral Economics while formulating its recommendations.

Link to the article published in Businessline:



The Indian Intolerance debate and Lessons from Paris Attack.


This is based on my conversations with several drivers, some corporate executives in The Hague and Paris and the pantry car/bar sales guy in the Thalys high speed train between Rotterdam and Paris, during the last week. All these conversation were for 15-20 minutes over drives except 3 which were fairly lengthy. If there is a surprising lack of rainbow of opinions that is the way it was. You are perfectly welcome to be sceptical about what I have written below. I am recovering from the surprise myself … so no offer of explanations or rationalisations. (Also pardon my grammar. Of late I have started seeing it more as a nuisance).

I was curious about the impact of the Paris bombing on life in Western Europe.

  1. In The Hague our first driver was a Mohd Rafi listening, Hindi speaking Surinamese. I was surprised that several generations after migration there is still such a strong cultural affinity in him. He dismissed having to face discrimination on Colour or nationality or religion in The Hague where he has been for the last 19 years. He is a Hindu.
  2. Our next driver, a Pakistani. I enquired if there was any animosity towards him in general and if after the Paris attack he is facing any animosity due to his religion (one could make out his religion easily). No not all. During the conversation, he mentioned that things in Holland, Belgium and France are not like the UK where discrimination is visible, perceptible and rampant according to him. I asked him how he knew. His dad migrated to the UK several years ago and he himself came to Holland in 2000 from UK and keeps going there every once in six months or so.
  3. In between I had spoken to 2 Algerian Muslims, an Afghan, 2 more Surinamese drivers (both Hindus), 1 Moroccan and a 3-4 Africans (i had language issues with them esp. in France) the views were pretty much the same. Only the Pakistani chuckled and said ‘unless the locals huddle secretly and talk behind my back’ … obviously to satisfy me more than out of conviction. An Iranian driver who appeared suave and erudite claimed that he has been in Holland for last 30-odd years and he has not felt any discrimination. He was aware that a blast took place but then he does not keep pace with daily news regularly and dismissed the whole conversation with a ‘shrug of shoulder’ – inconsequential it seemed to suggest.  (so many drivers since we were shuttling from place to place in taxis)
  4. Subsequently in Paris we were driven around by an Algerian Muslim who has been in France since he was Seven. He must have been with us for 7-8 hours through the day. I also spent about ½ hour with a Muslim (did not ask his nationality) owner of a street corner shop (Kirana store) right (actually on the left) next to Moulin Rouge while waiting for the show to open. Pretty much the same stuff.
  5. We had a dinner at Safron (Indian restaurant) near Notre Dame. It is co-owned (part) by a Hydrabadi Muslim, a civil engineer by education. He first spent 11 years in Baghdad in the late 70s and 80s (he quit in 1987 to come to Paris and has been in Paris since then). He had happy memories of Baghdad. Unlike some other countries in its neighbourhood, Baghdad did not prohibit drinking or smoking. There were also dance bars, music clubs, and some night life. On my question of discrimination he said, ‘We all work together and know each other and in our daily life interact so much. There is so much bon-homie and give and take. Before or after there is nothing of the kind you are enquiring after’ was his refrain. He did confirm that the Business had gone down sharply. At this time (9.30 pm) this place would have been milling with crowd; it is not the locals… they are out as usual: it is the foreigners who have stopped coming. It would take 2-3 months for things would revive. He works in Transportation business during day time (don’t know what it means) and evenings in the restaurant. He last went to India for his mother’s death (Hyd) in 2007 and could not go for his Fathers in 2011. His two brothers continue to live in Hyd.
  6. After the initial opinions counter to what I thought would be the case, I also spoke to my host professionals (3 Dutch and 2 from Paris who were very much there during the days of blast). And a 10-15 minutes talk with a slim, near 7 footer, humorous and garrulous Portuguese waiter at the restaurant (while we were waiting for the taxi and were perhaps the last ones to get out after a formal Dinner). They all had similar opinions and denied witnessing any discrimination. Perhaps one should not attribute the same level of significance to their opinions as the other set.
  7. I asked the Paris guys how life had changed for them since the attack. ‘Not much actually. The Government has done a fantastic job and will sure trace the remaining bits also and get the theatre up and running soon… We don’t believe it is the locals. Most likely they are from outside, perhaps Syria… There are 6 million Muslims in France and we have to live with them. We know most of them are more worried about their daily life, jobs and employment and income, like the rest of us and not much bothered about waging wars’. He gave me (on my asking) the names of places that were hit and told me that all of them were back to running and only the Opera or theatre hall at Le Bataclan is still under repair. There was no agitation in his (or his accompanying colleague) voice or gesticulations or expressions except for a trace of sadness. Similar conversations in India tend to fill up buckets of bile within minutes.
  8. I must mention however, that one of the people attending our meeting was a bearded Indian (Hindu actually) and he was frisked for 20 minutes at Schipol Airport.

In between these I met the guy (pantry/bar salesman in the train). I had gone there to take a tea, some snacks and water. He gave me those and a chocolate stick the size of index finger as bonus with a half-bestowing, half-‘I enjoy my work’ kind of smile, giving me the opening for a long conversation, interrupted many times by others approaching him for sales. He lives in Paris. Spoke English fluently.

1    I began by asking him, ‘how is life after the attack’. He was relaxed and did not burst forth with any pre decided answers like I used to jump at well rehearsed questions in my childhood years. “Yeah it was bad. But the government has done well to restore order quickly’.

‘How is it for you as an individual’

‘So long as you don’t believe the media and are sceptical about what the politicians say it will all be OK’. (A blast of a statement from him, I thought. They both (more so the former and less the latter) need some punching. I thought Indian media is the worst aggressor but things look same elsewhere too. (Later we discussed the media’s immaturity in some other context)

‘So no effect on you’

‘I do sympathize with the Victims and more their near and dear ones. But then I have to worry about my job, my family, children’s education, income and neighbourhood. Things are normal with these’.

‘So what do you think caused it’

‘I guess it may be the reaction to France’s bombing of Syria. But then the right wing was also getting increasingly edgy and aggressive here. But I don’t think it is the locals. There are many Muslims and we adjust to each other and we have to co-exist (some similarity of opinions there with my host Parisians)’.

2     Me: ‘You had mentioned about right wing. What is Mr Hollande?’

Him: ’He is Leftist. But you know all politicians are same. Till they are elected they are left, they are right, but then once in power they all do the same thing… Work for their own welfare, protecting their power base, etc. In that sense he is as right or left as any. And if not now will sure become a right very soon’.

‘What would you have done differently on this incident’

‘The Government pretty much did the right thing. They restored order quickly. Rounded up many involved and brought them to justice and will perhaps erect some monument or something for the affected. They saw it as a law and order problem’.

‘So nothing that you think could have been done better’

A slight shrug of the shoulder.

3     Me: ‘How do you think this problem can be solved?’

Him: ‘We should be conscious that a similar attack can take place and hence security at times has to be tighter. New entrants should be thoroughly checked and the border posts vigil has to be tightened’. (Must admit after his initial responses, this disappointed me somewhat).

‘What can France do about it as a nation?’

‘I think one of the reasons also may be we side with the US and since the disgruntled can’t hit them they hit us. That is a possibility. But then we can do very little about this. We need the US and we live similarly’.

We meandered on several other topics and came back to this topic.

4    ‘What can be the long term solution,’ I asked.

‘Both sides have to realise that this is circular. But we (he meant France and the Western World perhaps) have to realise we have far more to lose. I have my income, job safety, and my children go to schools, there is future for them. We have a good administration, a system which functions well. Most are well off and we have everything to lose. But what do they (terrorists) have to lose. Nothing. In that sense it is unequal warfare which we are destined to lose anyway. So if we are bombing them for Oil or religion, it’s time to stop it. We have a lot more to gain if this violence stops and we should be conscious of it’.

‘You think France can do it?’

‘Humh! France? There may be no one of that stature in France. But then what can we do alone? Our society and economy are so intertwined with the rest of Europe. And I don’t think they will allow us to do anything of that sort.

Me: ‘So it’s a problem which will linger’

Him: ‘Unless someone like Dr Mandela or Gandhi can rise to the occasion and stop it, it is not likely.

‘But then there is no one in the horizon. It is unlikely someone from Politics will do this’. (I did not know what to make of his last sentence. But then the interruptions were becoming more and i felt apologetic about disturbing him and wound up with a selfie. (I have however not posted the same since I have not taken his permission and it would be unethical to expose him without his consent)


I was deeply impressed with the maturity of his views, calm response to a disturbing national tragedy and the way ahead. As well as the calmness of my 2 Parisian hosts. I forgot to take his name or email id but he does the Amsterdam- Paris duty in the Thalys. (Unless the roster keeps changing).

I know it sounds surreal and unrealistic to see so much patience, tolerance from both sides, I did not expect it to be so one sided. I thought I would get a cross section of opinions. No luck. I have to blow my kisses to the people of France and salute their leaders and administration. For their extra-ordinarily mature and peaceful response. The politicians have not tried muddling the issue further. They have primarily treated it as a law and order problem and dealt with it. They have not tried ‘religionising’ it. Even if there was some right wing simmering, it was well controlled or they themselves perhaps saw it as not the fit occasion. My salutations to the Dutch as well on the issue of racialism or discrimination.

I would like to believe that i am a 100% Hindu, 50% Muslim (i have seen several of their places, read some of their literature and understand that the purpose of all the religion appear so starkly similar), 25% Christian and a large influence, of late, on my social behaviour from Parsis. But must admit in comparison to what i saw in my trip, that I(ndians) am racial and discriminatory and intolerant. I would reckon most of my friends are even more so. I don’t think it is the work of any politician in the last 12 months or 18. I don’t think anyone can bring about tolerance or intolerance within such a short time. It’s the way we are. We use every differentiating factor to mentally feel discriminated or administer it – caste, region, religion, colour, place, rich vs poor, etc. So if you are from the same community the benefit (and bias) will go in your favour, likewise same cadre, same service, same class (poor/rich). We are brushing too many things under the carpet named Gandhi…so instantly we become champions of secularism, non discrimination, non-violence and all other things nice to hear.

Know I am sounding pompous and preachy, but I think there is a lesson there from Paris and the way their people have responded, which we Indians are missing.