Why does the RBI have to write a letter to govt over inflation?

The Reserve Bank of India’s monetary policy committee held an off-cycle meeting on Thursday. The central bank’s rate setting panel usually meets bi-monthly to decide on interest rates, but this off-cycle meet was for different reasons. It was called to discuss and draft a report to be sent to the government. RBI has to give an explanation to the government if it fails to keep inflation in a fixed band for three quarters running.

What is the RBI mandate on inflation?

The Central government in 2016 provided a statutory basis for keeping inflation under control with a specific target framework. The government mandated that RBI and its monetary policy committee, with all the monetary tools available at its disposal, will keep inflation at 4 per cent with an upper tolerance limit of 6 per cent and lower tolerance limit of 2 per cent. To this effect, the government amended the RBI Act and entrusted the central bank with the primary objective of maintaining price stability while keeping in mind the objective of growth.

What happens if RBI fails in its mandate to control price rise?

If the inflation stays above the upper tolerance limit of 6 per cent for three consecutive quarters or the average inflation is less than the lower tolerance level for any three consecutive quarters, it is considered that the RBI has failed in its mandate to achieve an inflation targeting framework.

Now, when that happens, the RBI has to send a report to the Central government, in which it has to explain: A) The reasons for failure to achieve the inflation target. B) What actions does the RBI intend to take to bring inflation under control? The Central bank also needs to explain in the report an estimate of the time-period within which the inflation target of 4 per cent will be achieved.

What is the current scenario?

India’s consumer price based inflation has stayed above 6% since January, hitting an eight-year high in April. Price rise, triggered by various geopolitical reasons and Russia-Ukraine war, has caught many central bankers off guard. The RBI on its part started monetary tightening in May with an off-cycle interest rate raise and has since hiked the benchmark rate by 190 basis points. The consecutive hikes have taken the borrowing costs to pre-pandemic levels, but inflation is still at elevated levels.