Going beyond the inflation target

RBI has to manage multiple risks. Economists argue the system has got so used to lower rates and higher liquidity that a sudden tightening could lead to financial market dislocations

It was expected for a while but the September inflation numbers made it official. The Reserve Bank of India (RBI) has not been able to contain inflation as mandated by the law. According to the law, the central bank is expected to keep the consumer price index-based inflation rate at 4 per cent with a tolerance limit of 2 percentage points on both sides. If the rate remains outside the tolerance band for three consecutive quarters, it would be seen as a failure to achieve the target. The central bank, consequently, is required to write to the Union government, stating the reasons for the failure to achieve the target. It would also have to propose remedial measures, along with the expected timeline within which the target would be achieved.

The inflation rate for September increased to a five-month high of 7.4 per cent, and was above the tolerance band for the ninth consecutive month. While global commodity prices have come down, domestic food inflation could keep the headline numbers elevated. In September, for example, the consumer food price index-based inflation rate was at 8.6 per cent. Within the food basket, vegetable prices went up by over 18 per cent. Recent unseasonal rain in several parts of the country could keep vegetable prices elevated over the coming months. The RBI expects the inflation rate to come within the tolerance band in the last quarter of the fiscal year. In terms of immediate policy implications, since it was expected to happen, the breach would not change the policy response. However, it remains to be seen when the RBI writes to the government. RBI Governor Shaktikanta Das recently noted it would be a privileged communication between the RBI and the government. The central bank thus will not make it public. As argued by this newspaper before, the report should be made public. Releasing it will boost transparency and set a precedent for the future. Financial markets would also want to know how the central bank intends to deal with the situation.

Although the RBI delayed the process of unwinding crisis-time monetary accommodation, inflation is also partly driven by global factors. In fact, most economies, particularly in the developed world, are struggling to contain it. The US Federal Reserve has raised the policy interest rate by 3 percentage points this year and is expected to push it up further. The minutes of the Fed’s September meeting suggest officials are concerned about not doing enough to contain inflation. The International Monetary Fund expects global inflation to be at 8.8 per cent in the current year, and moderate to 4.1 per cent by 2024. This means interest rates would remain on the higher side. Some economists are arguing the system has got so used to lower rates and higher liquidity that a sudden tightening could lead to financial market dislocations. This would be a big policy problem for large central banks because, on the other hand, a slower policy response to inflation could de-anchor expectations with longer-term consequences. The actions of central banks in advanced economies will have implications for both inflation outcomes and financial stability in India. Thus, as the RBI prepares the report for the government, inflation is not the only concern that it will be dealing with over the coming months.