In a first, RBI may have to explain to govt why it couldn't curb inflation

Retail inflation has overshot the 6% upper tolerance limit for three years on the trot; experts say protracted Ukraine war and other factors may keep prices up

For the first time, the Reserve Bank of India (RBI) may have to explain to the government the reasons why retail price inflation has been overshooting the upper band of the mandatory tolerance limit of six per cent for three straight quarters.

Already, each month of the last quarter of FY22 saw the consumer price index (CPI)-based inflation rate at over six per cent. According to the Monetary Policy Committee's (MPC) own projection, the rate would touch 6.3 per cent in Q1 of the current financial year. The projection of the second quarter is 5.8 per cent. Now this is a touch-and-go kind of situation.

The MPC based its projections on the assumption of a normal monsoon, and average crude prices remaining $100 a barrel for 2022-23. Now, S&P came out with a report on the current account deficit based on a crude price level of $150 a barrel. If that does happen, CPI inflation in the second quarter of the current financial year may be over six per cent.

According to the monetary policy framework agreement between the RBI and the government, the former will be seen as failing in its inflation target if the rate of price rise is over six per cent or less than two per cent for three consecutive quarters. If this happens, RBI will set out in its report to the Centre the reasons for its failure to keep inflation within 2-6 per cent, the remedial actions it proposes to take and an estimate of the time period within which the inflation target would be achieved pursuant to the timely implementation of the proposed remedial actions.

Bank of Baroda chief economist Madan Sabnavis replied in affirmative when asked whether there was a chance MPC would fail to contain inflation at the upper band for three quarters on the trot.

"But there is an explanation of global factors driving all prices including edible oil, wheat, crude and metals. These can be called unusual conditions," Sabnavis said.

Icra chief economist Aditi Nayar said if the Russia-Ukraine conflict drags on and commodity prices escalate further, one could see the CPI inflation exceeding the 6 per cent upper threshold for multiple more months.

"A very protracted conflict which further disrupts energy prices ahead of the winter in the northern hemisphere could be particularly challenging," she said.

India Ratings chief economist Devendra Kumar Pant pointed out that the retail inflation in Q1 and Q2 of FY23 is expected to be higher than six per cent.

"This will make three consecutive quarters of retail inflation higher than six per cent. While a lot of it is due to supply disruption due to the Ukraine-Russia war, inflation of certain commodities such as health is turning structural," he said.

Besides explaining reasons for high inflation beyond six per cent, RBI will also have to tell the government two more things, as cited above.

On remedial measures, Sabnavis said the RBI has already started adjusting on liquidity. The central bank has been taking recourse to variable reverse repo rate mechanisms to absorb liquidity, he said.

After meeting of MPC, RBI governor Shaktikanta Das had said,"Currently, the liquidity management function of the RBI is characterised by two-way operations through variable rate reverse repo (VRRR) auctions of varying maturities to absorb liquidity; and variable rate repo (VRR) auctions to meet transient liquidity shortages and offset mismatches. Both these approaches will continue."

Sabnavis said there is a case of saying that the central bank is in a gradual and very calibrated manner taking out liquidity from the system.

However, MPC had left policy rates unchanged at the last meeting, though giving enough signals that controlling inflation will have more priority in its schemes of things.

"Interest rate measures will be a logical corollary that the central bank will do later on. It is going step by step," Sabnavis said.

So far as the time-frame to bring down inflation below six per cent is concerned, the Bank of Baroda chief economist said it would be difficult for anyone to specify a period within which it could be done, given that these are unusual circumstances.

"These are the conditions over which no one has any control. The central bank also has to keep growth in mind. It can't do anything at an accelerated pace," Sabnavis explained.

If the CPI inflation rate indeed crossed six per cent in three consecutive quarters, this will not be the first time. The inflation rate remained above six per cent for the four consecutive quarters from the fourth quarter of 2019-20. However, that time the monetary policy committee did not factor in April and May figures because those were imputed numbers since MoSPI could not get prices due to Covid-induced lockdowns in these two months.

“For the purpose of monetary formulation and conduct, therefore, the MPC (monetary policy committee) is of the view that CPI prints for April and May can be regarded as a break in the CPI series,” the MPC had said in its monetary policy statement in August 2020.

Table: Earlier instances when CPI inflation crossed 6% in four straight quarters

With imputed inflation in Covid-induced April and May of 2020 taken into account
Month	CPI Inflation rate in % YoY	Quarter	Average infaltion in various quarters
Jan-20	7.59	Q4FY20	6.67
Feb-20	6.58
Mar-20	5.84
Apr-20	7.30*	Q1FY21	6.81
May-20	6.90*
Jun-20	6.23
Jul-20	6.73	Q2FY21	6.89
Aug-20	6.69
Sep-20	7.27
Oct-20	7.61	Q3FY21	6.37
Nov-20	6.93
Dec-20	4.59

* Imputed inflation
 

Table: Recent inflation numbers

Month	CPI inflation rate (in % YoY)	Quarter	Average infaltion in %
Jan-22	6.01	Q4FY22	6.34
Feb-22	6.07
Mar-22	6.95
.	.	Q1FY23**	6.3
.	.	Q2FY23**	5.8

**MPC Projections