Come October, the Reserve Bank of India will, for the first time since it was six years back handed the job of inflation targeting, most likely be put in a tight corner and be required to explain to the government the central bank’s failure in tackling price rise and meeting the inflation target as mandated in the formal inflation targeting framework adopted in law in 2016.
The explanation on the inflation management failure will go in the form of a RBI Governor’s letter to the government and this letter will first be discussed at a specially convened meeting of the MPC in October, highly placed sources said. Only after the letter is discussed at MPC meeting will it be sent to the government, they added.
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RBI Governor Shaktikanta Das, who is also the Chairman of the Monetary Policy Committee, will have to write that letter to the Finance Ministry in October as the September retail inflation print is expected to be available by October 12, they added.
The RBI is clearly facing the brunt of an inflation crisis across the world with global spillovers — post the pandemic and Russia’s invasion of Ukraine since February — in the form of exchange rate volatility, elevated commodity prices and supply chain pressures having exacerbated imported inflation.
Crisis around the world
The only solace for the RBI is that pretty much every inflation targeting central bank around the world is facing an embarrassing failure due to the inflation crisis around the world.
Meanwhile, it is widely expected that the retail inflation in the country for September too will be above 6 per cent — upper range of the tolerance band of 2-6 per cent — and therefore lead to a breach of average inflation being above 6 per cent for three consecutive quarters since January this year.
Two quarters — March 2022 quarter at 6.34 per cent and June quarter at 7.5 per cent — have already gone by with average retail inflation above 6 per cent. The September quarter inflation is forecast to be about 7.1 per cent. The retail inflation for July had recently come in at 6.71 per cent, above the tolerance limit of 4-6 per cent for the seventh consecutive month.
“Our sense is that the consecutive three quarter breach will happen with July-September 2022 reading. So the MPC will discuss the RBI Governor’s letter in an exclusive meeting in October before sending it to Government”, sources said.
“It would be entirely for the Finance Minister Nirmala Sitharaman to take a call on whether this RBI letter should be tabled in Parliament or not. It will be a public document and it is up to the government to place it before Parliament or not. It is for the government to decide. RBI will not release it”.
The law mandates RBI Governor to write the letter to the government within 30 days from the date of breach of the inflation target.
The RBI Governor is not required to present himself before Parliament, but can appear before a Parliamentary Committee if requested to do so to explain the reasons for the inflation target breach, sources added.
The RBI Act was amended in 2016 to introduce inflation targeting framework. Post this move, the concept of Monetary Policy Committee (MPC) was introduced to set the policy rates in the country.
The inflation target given to MPC for 2021-26 is 4 per cent with 2 percentage points on either side, leading it to a tolerance band of 2-6 percent. This tolerance band is the same as the one given for the previous five years beginning 2016.
WHAT THE RBI GUV LETTER WILL SAY?
The RBI Governor Shaktikanta Das is expected to address three main issues in the letter. First, the letter will give reasons on what had led to the failure in meeting the target. Second point would be what measures the MPC proposes to undertake to bring down inflation and lastly over what time period does RBI propose to bring down retail inflation to 4 per cent.
As for the reasons that led to the target breach, the RBI Governor’s letter is expected to cite external factors that are beyond its control for this elevated and persistent inflation — global spillovers emanating from impact of pandemic and continuing Russia-Ukraine conflict.
On the measures that RBI could take, indications are that the letter would explain as to how the central bank has embarked on a policy rate tightening cycle and to what extend it could use this tool to increase the cost of money so as to control demand in the economy.
As for the timeline when RBI proposes to bring down inflation to 4 per cent, the letter may indicate the second half of 2023-24 with central bank estimating that retail inflation may fall to 5 per cent in April-June 2023.
RBI has to do a tricky balancing act as any strong measures of liquidity withdrawal to curb inflation should not lead to high growth sacrifices for the economy. It should balance between inflation control and growth without losing focus on growth. Clearly, the priority now is inflation control for RBI, but not by taking the foot away from the growth pedal, said economy watchers.
The inflation target framework has created an all round expectation that RBI will maintain inflation. The government — which has taken several supply side measures—is also equally concerned that retail inflation does not go out of hand . Also government may not relish any breach of inflation target as this was a reform introduced by the current dispensation, sources said.