This article is more than 2 years old.

January 13, 2015 This article is more than 2 years old.

In the run up to last year’s general elections, the Bharatiya Janata Party (BJP) had an acute sense of the one seemingly intractable problem that was unsettling Indian households.

Party propagandists, therefore, deftly coined slogans such as “Bahut Hui Mehngai Ki Maar, Abki Baar Modi Sarkar”—Enough of inflation; it’s now time for Modi’s government.

Yet, inflation fell to single-digit figures even before the BJP government came to power.

So, what was it that brought retail inflation down from 11.24% in November 2013 to 5% for December 2014, after touching record lows of 4.38% in the previous month (November 2014)?

And what factors controlled the wholesale price index, which fell to zero for November 2014, lowest in five-and-half years?

Effectively, there were three major reasons why inflation subsided, to drop much below the Reserve Bank of India’s (RBI) target of 8% by January 2015 and 6% by January 2016.

Falling domestic and global prices

Firstly, food and fuel prices that had significantly spiked during 2013 condensed. These two items together constitute 57% of the consumer price index (CPI), which measures the change in prices of a select basket of goods and services over a time period for Indian households.

Simultaneously, vegetable prices plummeted 13.2% between December 2013 and January 2014 primarily on account of greater supply.

The better prices fetched during the tail end of 2013 helped farmers bring more land under cultivation, and plant more, thus producing more, leading to an oversupply in early 2014. “Higher production in 2013-14 has been achieved by expanding acreage,” said the Economic Survey 2013-14.

Crashing oil prices also helped. Global prices of crude oil—which generates the biggest import bill for India—have been dropping since June 2014.

From $111.25 per barrel in the middle of June, 2014, US crude prices dropped by over 95% to $56.55 per barrel in December 2014.

RBI’s measures

It did not take long for the Reserve Bank of India’s governor Raghuram Rajan to realize the urgent need to curb easy money flow to the hinterland through agricultural loans and the National Rural employment guarantee (NREGA).

“More loans to agriculture have fostered substantial private investment in agriculture, but may also have pushed up rural wages,” Rajan said six months after taking charge in early September 2013.

“The rural wage growth,” Morgan Stanley’s Chetan Ahya and Upasana Chachra explain in a January 16, 2014 report, “has been one of the key factors resulting in higher food, services and overall CPI inflation.”

Key indicators also pointed to the problem in the rural economy. Barring October and November 2014, rural inflation has been higher than urban inflation throughout the calendar year.

Suppressing this easy flow of money into the hinterland was tackled by maintaining high interest rates. The RBI hiked the repo rate by 0.25% to 8% in January 2014, the third raise since Rajan’s appointment.

Later in June 2014, reducing the repo rate—rate at which the RBI lends to banks—would have meant filling rural pockets with cheaper farm loans. Instead, the RBI resorted to multiple cuts in the statutory liquidity ratio (SLR), which are the funds that banks need to compulsorily invest in government bonds.

On June 3, 2014, the SLR was reduced by 0.50% to 22.5% and by another 0.50% on Aug 5 to 22%, thus shrinking the market for government securities and enlarging availability of cheaper credit to the private sector.

By late 2014, Rajan had reason to be satisfied with the rural wage growth numbers, as average growth in daily wage rate for farmers stood at a modest 10% in June 2014 as compared with 16.3% in 2013.

Curbing exports

The last nail in the inflation coffin was a series of changes in agricultural exports and marketing policies, as prices started inching up again between June 2014 and July 2014.

The Modi government dis-incentivized agricultural exports and introduced curbs on the grain stock, the level of which had doubled under the previous United Progressive Alliance government.

The grain stock at the beginning of June 2014 was nearly 75 million tonnes—28 million tonnes higher than what the government requires to run various subsidy programmes and emergency stock.

The government also cracked down on hoarders and sold 50 lakh tonnes of rice reserves in the open market during mid-July 2014. That helped cool food grain prices.

Meanwhile, to reduce prices of fruits and vegetables, finance minister Arun Jaitley announced a slew of measures. These included allowing farmers to sell directly in the open market. The artificial price rise often induced by middlemen and traders was partly curbed.

It also helped that restrictions on minimum support prices—the price at which the government purchases crops from farmers irrespective of the final market price of the crops—were introduced to stem exorbitant price rise.

What’s next

As inflation dropped to a two-year low of 8.79% in January 2014, the RBI governor has been assailed by calls for cutting key rates.

He has, of course, defended his stance often.

“If lower rates generate higher demand and higher inflation,” Rajan said in a speech on February 26, 2014, ”people may produce more believing that they are getting more revenues, not realizing that high inflation reduces what they can buy out of the revenues…bursts of inflation can generate growth for some time.”

But when the corroborative steps and easing global crude prices have led to inflation reducing to 5% in December 2014—a little less than the target of 6% for January 2016—why is the RBI not relaxing rates?

That’s because the central banks expects the number to surge to 8% between January and March 2015. “With favourable base effects reversing in the following months inflation is likely to climb back,” the RBI said in its September Monetary Policy Report.

Softening crude prices, however, might slow down this climb. With the crude oil basket prices hovering around $53.65 per barrel, inflation may be dampened for longer. The forecasts of inflation hovering around 7% plus have now reduced to 5.5-6% on an average panning over the next 12 months.

Meanwhile, rate cut expectations have been building up steadily.

In 2015, economists expect a total of 50-75 basis points (0.50-0.75%) cut in the repo rate.

In all likelihood, this could be staggered—with the first cut being anticipated after the budget at the end of February, if not earlier that month when the RBI will hold another policy meeting.