Are RBI's hands tied when it comes to inflation?

India’s retail inflation, based on the Consumer Price Index, soared to 7.4% in September, up from August’s 7%. This rise was fuelled by higher food prices. 

Data released by the National Statistical Office showed that food inflation, which accounts for nearly 40% of the CPI basket, came in at a 22-month high of 8.6%. 

The latest reading highlights the Reserve Bank of India’s challenges in bringing inflation within its medium term target of 4%, with a variation of 2 percentage points on either side.

Inflation has now remained above RBI’s upper tolerance level of inflation of 6% for three consecutive quarters. RBI Act says that the central bank will have to submit a report to the central government explaining the reasons for failing to meet the inflation target and remedial steps to rein in the price rise.

RBI is facing such a consequence for the first time since the onset of the inflation-targeting Monetary Policy Framework that came into effect in August 2016.

Last month, RBI Governor Shaktikanta Das had said the central bank considers the communication to the government missing the inflation targets as privileged communication and will not be making it public.

Inflation had overshot the target for over three quarters during the initial months of the pandemic as well, but a technical shortcoming in the data collection, wherein data was collected without visiting the mandis because of the lockdown, had helped ensure that no such explanation has to be done by the RBI at that time.
 

RBI’s Monetary Policy Committee has raised the repo rate by 190 basis points since May to 5.9%, and economists expect it to raise rates yet again by at least 25 basis point at its next meeting in the first week of December. 

Late withdrawal of monsoon and intense rain spells seen in some states has had an impact on the price of perishables, especially vegetables. 

During September, prices of vegetables increased 18.05% from a year ago while cereal prices rose 11.53%

Spices added to broad-based food price pressure with 16.9% inflation. Clothing and footwear prices jumped 10.17% while fuel and electricity prices increased 10.39%, staying above the 10% mark for the fourth consecutive month.

Key rice producing states such as Uttar Pradesh, West Bengal, Jharkhand reeled under excessively deficit rainfall this season, weighing on paddy sowing and anticipated output. The weakening of the rupee by over 10% this year has made imports costlier for consumers and businesses.

Meanwhile, industrial output contracted 0.8% in August after showing a 2.2% growth in July. A note by QuantEco research said that slowdown appeared to be broad based with noticeable drag in consumption-oriented production even as investment-oriented production too has seen loss of momentum in recent months.

The International Monetary Fund on Tuesday cut its growth forecast for India to 6.8% for 2022-23. 

Speaking to Business Standard, Vivek Kumar, Economist, QuantEco Research says food and fuel accounted for 62% of Sept inflation. They are largely interest rate agnostic. Transmission of rate hikes takes 2-4 quarters. We hope MPC would raise rates by 35bps in Dec. 

Since the inflation print is heavily influenced by food prices, which are volatile and lately affected by global development, the RBI’s toolkit is limited. Thus, actions by the central bank will have to be complemented by further government steps on non-core food and fuel items. Failure to do so will damage India’s inflation-managing credentials.