The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) will have a special meeting on 3 November 2022 to discuss its responses that it will send to the Government on the reasons for inflation breaching the upper tolerance of MPC for three consecutive quarters. As per Section 45ZN of Reserve Bank of India Act 1934, the RBI has to set out a report to the Central government stating the reasons for not achieving the inflation target, remedial action proposed to be taken and an estimated time frame within which inflation will be brought under target.
In this context, it is important to give a historical perspective. The Reserve Bank of India Act 1934 was amended by the Finance Act 2016 “to provide for a statutory and institutionalized framework for a Monetary Policy Committee, for maintaining price stability, while keeping in mind the objective of growth”. The MPC is assigned the job of setting up the benchmark policy rate to control inflation within the target level. The inflation target was set at 4% with upper tolerance at 6% and lower tolerance level at 2%. The first meeting of the MPC was held in October 2016. The flexible inflation targeting regime in India attempts to ensure price stability and is mindful about growth objective. Ever since the inflation targeting was positioned in India in 2016, this is the first instance when inflation remained higher than 6% which is the upper tolerance of MPC for three consecutive quarters between January 2022 and September 2022. Earlier during the period of Covid-19 pandemic between April 2020 to November 2020, inflation was higher than 6% for eight straight months due to supply side bottlenecks caused by the pandemic.
Inflation has become a global phenomenon with most of the countries battling with stubbornly high inflation that stayed above the target levels of their respective central banks. Consequently, many countries have negative real interest rates. Inflation has moved higher globally, firstly, due to Covid-19 induced supply side bottlenecks and secondly, the Russia-Ukraine war has led to energy crisis particularly in European countries that resulted in higher inflation. Recent IMF’s projection shows inflation to increase by 8.8% in 2022 from 4.7% in 2021. Tight demand-supply balance kept the crude prices elevated ever since the war broke out. Brent crude touched USD 133.18 per barrel on 08 March 2022. Global food prices increased above 30% on year-on-year basis in March and April 2022. Although global food prices have decreased recently, it is still about 12% higher compared to last year by end of September 2022. Similarly, base metal prices grew above 30% year on year in February and March 2022.
Higher global inflation had spill-over effect on domestic inflation. The wholesale price inflation went above 15% between April to June 2022 due to broad increase in prices across primary, fuel and manufacturing components amid Russia-Ukraine war. Sharp rise in manufactured products led to pass-through of input cost pressures to retail inflation.
Domestically, the food inflation—a major component in the consumer price inflation—remained higher in all these months. Barring January and February, food inflation remained above 6% during 2022 till September. Food prices had to go through various shocks in the recent times. Among the food items, cereal prices have remained higher due to firstly the heat wave in the northern part of India that impacted the production of wheat. Government had to put a prohibition on export of wheat to control prices earlier. Moreover, uneven monsoon rains hit paddy sowing that needed the government to ban export of broken rice and imposed 20% export duty on certain non-basmati rice. Vegetable prices have remained above 10% in last seven consecutive months till September. Flood in some of the regions, uneven spatial distribution of rainfall during monsoon and lower base of last year had contributed to higher vegetable inflation. Moreover, inflation in oil & fats category spiked with edible oil prices increased due to Russia-Ukraine war that led to supply disruption as India imports substantial crude sunflower oil from Russia and Ukraine. Additionally, the temporary palm oil export ban by Indonesia had its impact on edible oil inflation. India consumes about 24 million tonnes of edible oil annually of which 13.5 million tonnes is imported. The Government of India provided concessional custom duty on import of edible oil to control domestic prices. In September, the inflation in oil & fats moderated to 0.37%. Earlier, the government also cut excise duty on petrol and diesel to control inflation as crude oil prices remained elevated globally. With the economy opened up post pandemic, the demand for services have increased that could lead to higher prices. The core inflation (excluding food and fuel) remained sticky and hovered around 6%.
To control inflation, the MPC has increased the repo rate by 190 basis points to take it to the level of 5.90% till September. The MPC started to increase the policy repo rate in this rate hiking cycle in May with an off-cycle meeting wherein it delivered a 40 basis points increase in repo rate. In April, the RBI introduced the “standing deposit facility” as the floor of the liquidity adjustment facility corridor. It also removed the “accommodative” word from its monetary policy stance in June and continued with its stance of “remain focused on withdrawal of accommodation”. Depreciation of rupee has also led to inflationary pressures with elevated crude and commodity prices. RBI has been actively intervening in the forex exchange market to curb volatility of rupee amid aggressive rate hikes by the US Fed.
As future course of action in its battle against inflation, the MPC is expected to continue with its rate hikes and take the terminal repo rate to around 6.50-6.75% levels. Inflation is expected to be about 6.7% for 2022-23 with some moderation in second half of 2022-23. Further the inflation is expected to come down to about 5.1% in 2023-24 on relatively lower global commodity prices. Moreover, easing momentum and favourable base in food prices along with normal monsoons will help overall domestic inflation to come down.
Dr Sudarshan Bhattacharjee is Principal Economist, Yubi (Formerly CredAvenue).