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The trouble with RBI's glide path to bring down inflation

With high-frequency indicators looking upward, economists increasingly believe it is time for the MPC to pay greater heed to tackling inflation (REUTERS)Premium
With high-frequency indicators looking upward, economists increasingly believe it is time for the MPC to pay greater heed to tackling inflation (REUTERS)

With high-frequency indicators looking upward, economists increasingly believe it is time for the monetary policy committee to give more weightage to tackling inflation. A delay could force faster policy rate hikes in future, potentially disrupting the gains achieved by the wait-and-watch approach

Come Friday, the panel tasked with keeping India’s inflation in check will announce its latest monetary policy review. The last two prints, both below 6%, have come as a big relief to the panel, which had earlier claimed high inflation was “transitory". But analysts fear that with underlying price pressures very much alive, too much comfort for long can bring the Reserve Bank of India’s (RBI’s) credibility under the scanner.

As recently as last month, RBI deputy governor Michael Patra talked about a stretched “glide path" to bring inflation down to the 4% central target only by 2023-24. So far this year, the monetary policy committee (MPC) has looked through inflation well above that figure in favour of sustaining recovery from the pandemic. Moreover, the panel’s exit plan from its unprecedented stimulus is hardly clear.

A closer look shows that if anything was transitory, it was the recent moderation: it was driven mostly by base effect, which is set to wane soon. A sequential price build-up shows inflationary pressures are far and wide, from food and fuel to services and global commodities. “If inflation remains elevated for long, it becomes entrenched," said Yuvika Singhal, an economist with QuantEco Research. “Everything from inflation expectation to wage revisions—there are repercussions. And then, it gets difficult to correct it quickly."

With high-frequency indicators looking upward, economists increasingly believe it is time for the MPC to pay greater heed to tackling inflation. A delay could force faster policy rate hikes in future, potentially disrupting the gains achieved by the wait-and-watch approach.

Visible pressures

In India, inflation so far during the pandemic has been led by supply-side constraints, which could not have been managed by monetary policy. While those factors still remain, the MPC must not ignore some new ones that are also on the rise.

Vegetable prices may have ebbed, but an uneven monsoon and high international food prices, as well as rising domestic prices of several food items, still pose risks. Fuel prices remain propped up, and a Goldman Sachs forecast of crude oil rising to $90/barrel by year-end doesn’t help. Dearer petroleum products could spill over to other items, too: core inflation is already elevated, and sticky.

Upcoming festivals could only add demand-side pressures at a time when global supply constraints are nowhere close to ending soon. Inflation expectations have been rising, too, and could feed into headline inflation with a lag. All this adds up to suggest that the recent inflation drop could begin to reverse by the end of the year.

MPC’s Trade-offs

More than a year after the pandemic forced the RBI to cut key policy rates to record lows, the economy is finally showing signs of recovery that the MPC might have been waiting for. Most estimates now see GDP reaching pre-pandemic levels in 2021-22, one key reason that analysts believe it’s time to shift the focus back on inflation.

To be sure, this does not necessarily mean immediate policy tightening but being open to managing inflation, should it go above the 6% mark again. Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership, said the MPC should “give greater weight to inflation in monetary policy than it has in the past two years."

Instead, Patra’s glide path suggests an inclination to tolerate high inflation for longer, said Sonal Varma, an economist at Nomura. “The policy choice for the MPC to fall behind the curve comes with the risk of a faster catchup next year," she warned.

GDP to go back to pre-pandemic levels in FY22
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GDP to go back to pre-pandemic levels in FY22

Falling behind?

For much of 2021, central banks globally have waxed eloquent about “transitory" inflation and fragile growth to justify loose pursestrings. But as growth gets going and high prices become the concern, some have started retreating, or are at least communicating exit plans. But in India, if Patra’s stance—tolerating 4%-plus inflation to support growth—translates into actual policy, it could soon put the RBI behind the curve.

“Many advanced economies are facing inflation above their upper bound, and in that sense, the RBI still managing inflation within its [2-6%] band is a big success," said N.R. Bhanumurthy, vice chancellor at BR Ambedkar School of Economics University. “However, the inflation narrative could change significantly in coming months in line with what is happening in international markets."

Since early 2019, long before covid-19, the MPC’s focus had moved to growth under Shaktikanta Das’ tenure as RBI governor. As inflation threatens to get persistent, all eyes will be on the MPC this Friday to see if they finally change tack.

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