Is inflation here to stay?

People will be talking about two things today: Rahul Gandhi’s 90 minute long interview to Times Now and RBI Governor Raghuram Rajan’s decision on the interest rate. The effect of what Mr Gandhi said will not last beyond a day or two; the effects of what Mr Rajan does will last for much longer, a year at least if not more.

His main brief from the PM would have been to get the inflation down, never mind what the corporate sector says about the price of money. But as 2014 gets underway, the questions that need answering is whether the RBI will succeed and if not why not.

I think it won’t succeed because (a) India is now too globalised and (b) inflation has become embedded in the economy in the same way it had done in the early 1970s.

The consequence of globalisation, in policy terms, is that the RBI has to decide which – the interest rate or the exchange rate – will bear the greater burden of anti-inflation policies. The response will depend on the context. And the context is the embedding of inflation because of supply side rigidities in the three mains sectors of the economy: agriculture, manufacturing and finance.

Agriculture is stuck because of the small and decreasing size of farm holdings. Of the 140 million farming households, slightly over 100 million have holdings of less than one hectare or less.

Industry is stuck because there isn’t enough land, power, and water, not to mention transport for moving the output.

Finance is stuck because the public sector banks are jamming up the works. They still account for around three quarters of the banking business in India but serve a political rather than a commercial purpose.

The fact that agriculture is stuck means the wrong sort of urbanisation is increasing and with it so is the number of net buyers of food. This is placing a huge pressure on prices. That is why the finance ministry doesn’t want the CPI to become the target for inflation. It is this food problem – too many buyers, too few producers -- that lies at the heart of the inflation problem. No amount of tweaking of the interest rate is going to solve it.

The only alternative is to import. That means exporting more to pay for the imports. This, in turn, means choosing the interest rate as the target variable for inflation control rather than the exchange rate. And that means slower growth which means higher inflation.

In short, we are in for a hard ride which is why sensible people have started shifting out of financial savings into gold and real estate. You should do the same.