RBI’s secret letter on missed inflation target: What MPC minutes tell us

The RBI has failed to bring down the rate of inflation below the upper limit of 6 per cent in the last three quarters or nine months. Inflation has remained above the 4 percent target for more than three years now, or so during the tenure of Governor Shaktikanta Das, who as economic affairs secretary in the Modi government, steered amendments to the RBI Act through parliament. Were. He also coordinated the transition to a formal inflation-targeting regime with the central bank on behalf of the government, through which New Delhi aimed to strengthen the credibility and accountability of the RBI, because ultimately it is the political class on which voters rely. They are questioned by and often punished. for price rise. He is now abiding by the amended law – and he is the first RBI governor to have failed on the inflation target.

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The amended law requires the RBI to explain in writing the failure to keep inflation within the tolerance limit for three consecutive quarters, the reasons for the failure and the steps to be taken by the central bank to bring inflation under control. The RBI’s Monetary Policy Committee (MPC) met on November 3 to prepare this clarification letter to the government. Das has said that the RBI will not make public the clarification being sent to the government. However, it is expected that the government will make it public since inflation and the failure of the RBI is a matter of public and parliamentary scrutiny.

If it does not, the statements made by MPC members in recent meetings could be a good indicator of what is likely to be included in the RBI clarification letter. Mint Snapview studied the official minutes for potential indicators.

In the minutes published on October 14, 2022, RBI Deputy Governor Dr. Michael Debabrata Patra’s statement shows that the central bank cannot blame itself by arguing that global factors have made it difficult to project inflation and its This has complicated monetary policy choices and their effectiveness, which means that lowering prices will require a large sacrifice of growth. It can skillfully deflect accountability at the door of systemic central banks (the US Federal Reserve in other words) and argue that most of the inflation in India is imported inflation. Dr Patra’s statement also suggests that the RBI does not see itself in a position to bring inflation under control before 2022 or 2023.

This inflation shock defeats the traditional forecasting model. The parameters that characterize recent developments are far outside the limits predicted by conventional models. …the currently available inflation projections suggest that real policy rates will remain negative until close to 2022. Therefore, monetary policy may need to be tightened more strongly in 2023 if terminal rates are to be achieved…

For net commodity importers such as India, with imports exceeding a third of the CPI, a negative terms of trade shock complicates macroeconomic management…

No country is immune. Systemic central banks should heed the possibility that today’s spillovers could become tomorrow’s spillbacks…

Forward-looking surveys by RBI suggest that selling prices in manufacturing and services may rise further as pass-through remains incomplete due to input cost pressures. Exchange rate volatility is exacerbating these core price pressures…

His statement in the minutes published on August 19, 2022 adds to the list of reasons for the failure of the RBI to add the COVID-19 relief stimulus to advanced countries.

With inflation rising around the world and a widespread sense of guilt about the consequences of the pandemic stimulus has been undermined, central banks have tightened the most aggressive, front-loaded and synchronized monetary policy in decades…

In the same statement, Dr. Patra also addressed the question of what the RBI is doing to control inflation, explaining that it is pushing interest rate hikes.

Monetary policy response to supply shocks should be based on managing expectations and strengthening credibility…Credibility is demonstrated by stepping up monetary policy actions, showing commitment to the inflation target.

Dr. Shashank Bhide’s statement in the minutes published on August 19, 2022 suggests that the prolonged Russia-Ukraine conflict and supply disruption would be one of the reasons given by the RBI in its clarification letter.

The prolonged Russia-Ukraine conflict and supply disruptions are a major source of uncertainty for price trends, particularly for energy and food commodities. The direct impact of supply disruptions, even if targeted to certain geographical areas, is quickly transmitted elsewhere to meet the overall demand supply imbalance.

The statement by RBI Executive Director Rajiv Ranjan in the minutes published on June 22, 2022, made similar points on the sources of inflation.

The ongoing war in Europe and the resulting sanctions have taken a toll on the global economy by exacerbating supply chain disruptions and increasing uncertainty about the post-pandemic recovery. With inflation reaching multi-decade peaks in many countries and remaining stubborn, the risks of destabilizing long-term inflation expectations have multiplied, leaving little room for monetary officials to maneuver.

His statement in the minutes published on August 19, 2022 indicates that on steps taken to fight inflation, the RBI may point to a rate hike starting from the unscheduled MPC meeting in May this year.

Inflation expectations of households in India, looking adaptive and backward and primarily influenced by price expectations of food and fuel items (which constitute about 55 per cent of the CPI basket), moderated in the July 2022 round but remained high. level remained. Lowering inflation expectations in the context of post-conflict inflation growth in Europe is the biggest risk the MPC addressed through off-cycle meet and frontloaded rate action to increase the efficacy of the actions.

In the minutes published on October 14, 2022, Prof. Jayant R. Verma’s statement suggests that the RBI may say that even after taking the repo rate to around 6 per cent, six quarters or up to 18 months would be required to bring inflation under control.

It may take 3-4 quarters for the policy rate to transfer to the real economy, and up to 5-6 quarters for peak impact. If we raise the repo rate to around 6 per cent in this meeting, it will be a cumulative increase of about two percentage points in a span of just four months. It even undermines the extent of monetary tightening, as a few months back, money market rates were close to the reverse repo rate (65 basis points below the repo rate). With this in mind, the absolute magnitude of the monetary tightening would be over 250 basis points.

Much of the impact of this major monetary policy action is yet to be felt in the real economy…

…Since monetary policy works with a lag, what is relevant is the inflation forecast 3-4 quarters ahead. Both the RBI forecast and a survey of professional forecasters indicate inflation falling to around 5 per cent in the first quarter of the next financial year.

Do these points sum up the failure of RBI? Not necessary. The RBI has not had to deal with the kind of loose fiscal policy that the US Treasury chose to do and stimulate the US economy. Second, India has not faced a food price crisis since the war in Ukraine due to a comfortable buffer stock policy and the Modi government’s plan to provide free food grains. Energy inflation is also under pressure as India is buying subsidized crude from Russia. It is unconscious that inflation (what economists call core inflation) in India, excluding food and fuel prices, has been at an average upper tolerance limit of 6 per cent for more than a year.

If CPI inflation remains above the target level of 4 per cent for three years now, it is because the RBI has not taken the inflation target seriously. It was quite comfortable with inflation at 6 percent, and instead committed itself to boosting growth, but neither the revival in private investment needed for quality GDP growth, nor low inflation. It was content to confine itself to liquidity operations. The MPC began raising interest rates only when inflation crossed the upper tolerance limit, knowing full well that monetary policy shows results with lag.

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