Not convinced of durable fall in inflation: RBI Deputy Guv Michael Patra

CPI inflation was at 6.7% in July, the first time in four months that the price gauge fell below 7%

While headline retail inflation appears to be easing from a peak of 7.8 per cent in April, the central bank would prefer to await more incoming data before being convinced of the durability of the trend of moderating consumer prices, Reserve Bank of India (RBI) Deputy Governor Michael Patra said.

“While some easing of international commodity prices and supply chain pressures, both globally and domestically, are positive developments, upside risks remain in the form of potential second-order effects and the transmission of input cost pressures to the sticky core component of inflation,” Patra said, while delivering the keynote address at the at the SAARCFINANCE Seminar at New Delhi on August 24.

In an interview with a television channel on August 23, RBI Governor Shaktikanta Das said according to the central bank’s assessments, inflation had peaked and was expected to moderate going forward.

The RBI, which has projected consumer price index- (CPI-) based inflation at 6.7 per cent in the current financial year, has a medium-target of maintaining retail inflation at 4 per cent, with a flexibility of 2 per cent on either side.

CPI inflation was at 6.7 per cent in July, the first time in four months that the price gauge fell below 7 per cent.

According to Patra, the near-term inflation trajectory continues to be heavily contingent on evolving geopolitical developments, international commodity market dynamics and developments in global financial markets.

“At the current juncture, our experience is that by frontloading monetary policy actions, credibility is demonstrated by showing commitment to the inflation target,” Patra said.

“Another dimension of monetary policy credibility is the timing of its response. A delay in the monetary policy response leads to a further loss of credibility, unhinging of inflation expectations and eventually, higher inflation outcomes with a higher sacrifice of growth,” he said.

The RBI’s Monetary Policy Committee (MPC) has raised the repo rate by a cumulative 140 basis points since May. The policy rate, which was slashed to a record low of 4 per cent during the pandemic, is at 5.4 per cent.

Upside risks to inflation increased significantly after Russia’s invasion of Ukraine in late February as the conflict led to a surge in global commodity prices.

The rupee’s depreciation against the greenback in the face of higher US interest rates has added to inflationary pressures by making imports of dollar-denominated commodities more expensive. The domestic currency, which has depreciated close to 7 per cent so far in 2022, weakened to a lifetime low of 80.06 on July 19.

“In its latest meeting in early August, the MPC decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth,” he said. The RBI is simultaneously engaged in a multi-year, calibrated withdrawal of liquidity infused into the economy during the Covid crisis, Patra said.

Emphasising the strong accountability criteria embedded into the inflation targeting framework which was adopted since 2016, Patra pointed out that India’s inflation averaged below 4 per cent during 2016-20 before rising to 6.2 per cent in 2020-21, the year the pandemic struck.

“...Our response to inflation shocks such as the one we face today has to be predicated on managing expectations and fortifying credibility. If credibility is high and the shock is transitory, inflation returns to equilibrium without the need for any monetary policy action,” Patra said.

“On the other hand, repeated supply shocks — which we are encountering now — trigger second round effects through cost pushes, expectations, exchange rate and demand channels, warranting pre-emptive monetary policy action,” he said.

The RBI Deputy Governor said even with perfect credibility, monetary policy cannot look through the second-round effects of repeated supply shocks.

The central bank has taken many initiatives to strengthen inflation monitoring and improve the accuracy of forecasting, Patra said.