RBI likely to cite supply issues for failure to meet inflation target
The Reserve Bank of India’s (RBI) letter to the government, triggered by its failure to keep inflation within the target band, will likely blame supply-side issues for the runaway price rise, economists said
The Reserve Bank of India’s (RBI) letter to the government, triggered by its failure to keep inflation within the target band, will likely blame supply-side issues for the runaway price rise, economists said.
Under Section 45ZA of the RBI Act, the government, in consultation with RBI, sets the medium-term retail inflation target once in five years. Failure to meet the current target of 2-6% for three consecutive quarters—January through to September in this case—requires RBI to write a letter to the government, explaining why it missed the goal. Retail inflation for September accelerated to 7.41%, staying above the 6% upper bound of the inflation target for three straight quarters.
The letter will have three parts: reasons for failure to achieve the inflation target; remedial actions proposed by the central bank; and an estimate of the time within which the inflation target shall be achieved.
Economists said RBI is likely to tell the government that it has raised interest rates to control demand in the economy and that the rest depends on fiscal measures to rein in supply-side problems. These include improving food supply and building domestic capacity for edible oil production.
“RBI would probably tell the government that inflation has been going up primarily because of supply-side issues over which it has little control. Food and fuel inflation going up are not directly under the purview of the central bank," said Madan Sabnavis, chief economist at Bank of Baroda.
Sabnavis said RBI has a strong case to say that supply-side issues are causing inflation and that it has already taken corrective measures. “As a central bank, you can control liquidity and regulate demand by managing interest rates, both of which RBI has done," he said. Beginning with a surprise hike of 40 basis points (bps) in May, RBI has hiked rates in every policy since, taking the total hike in this cycle to 190 bps as of 30 September.
In fact, RBI deputy governor Michael Patra is cited in the minutes of the monetary policy committee’s 28-30 September meeting as saying the moderation in domestic inflation that began in May 2022 was interrupted by supply shocks.
According to RBI’s estimates, inflation will cool to 5.8%—within the target range—only by the March quarter of FY23.
“In February and March, inflation looked to be more manageable, and had the Ukraine war not happened, RBI would have been able to get it below 6% much more quickly," an economist said on condition of anonymity.
He said the more interesting reference to watch out for in the letter would be RBI’s forward guidance on the inflation trajectory, as it is expected to have many more details than what is in the public domain.
On 30 September, RBI governor Shaktikanta Das called the letter a “privileged communication between RBI and the government" and declined to make the letter public.
However, another economist who spoke on condition of anonymity said it should be made public because failure to do so would defeat the whole purpose of holding RBI accountable for its actions.
“RBI will tell the Centre that whatever it has done so far—raising rates and controlling liquidity—will continue. It is also likely to state that the central bank had gone into an ultra-accommodative stance during covid and, therefore, liquidity is taking longer to withdraw," the second economist said.
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