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EconomyMPC misses inflation target: How RBI may explain lapse to government

MPC misses inflation target: How RBI may explain lapse to government

This is the first time since the inception of the MPC in 2016 that the panel is failing on its inflation mandate and hence its explanation better be convincing

The Reserve Bank of India (RBI) announced on 27 October an unscheduled but expected additional meeting of the Monetary Policy Committee (MPC) to be held on 3 November following the central bank’s failure to meet the mandated inflation target of 2-6% for three consecutive quarters. Inflation averaged 6.3% in January-March, 7.3% in April-June and 7% in July-September. The MPC is tasked to keep inflation in the country under 6% always, come what may.

In such a scenario, the RBI can conduct an unscheduled meeting of the MPC as mandated by Section 45ZN of the RBI Act, which relates to a “failure to maintain inflation target”. The originally scheduled MPC meeting was on 5-7 December.

Such a failure warrants the RBI-led MPC formally writing a letter to the government, offering an explanation for the failure and corrective measures. But what will the rate-setting panel tell the government? Possibly that the RBI has limited tools to fight inflation, especially when the inflation is demand-driven and triggered by external factors.

Technically, the RBI is entitled to tell the government, ‘It’s your fault,’ but the Shaktikanta Das-led body is unlikely to charter a collision course with the Narendra Modi regime. So, the following are the other possibilities.

An economist at DBS Bank, Radhika Rao says the central bank would likely pin the slip on “exogenous supply-side pressures” such as the Russia-Ukraine war, which triggered a sharp rally in commodity prices, supply chain disruptions, and the fallout of the Covid-19 pandemic. Also, the US Fed rate hikes, upon which the RBI has no control, have a bearing on the local currency and the inflation, India’s central bank may add.

In other words, the MPC will defend itself, saying that the current rate of inflation is primarily caused by supply-side shocks.

This is the first time since the inception of the MPC in 2016 that the panel is failing on its inflation mandate and hence its explanation better be convincing

Rao gets this idea perhaps from the fact that RBI Deputy Michael Debabrata Patra had suggested something similar in a speech in June. “India is being impacted by the global inflation crisis, reflecting the materialising of geopolitical risks,” Patra had said.

Moreover, as Shaktikanta Das had said in August, the RBI expects inflation to fall to 4% over a two-year period. The central bank’s letter may, therefore, stick to that timeline, analysts say.

Furthermore, the MPC may cite the sharp depreciation in the rupee as a contributing factor to higher inflation. A weak rupee discourages imports as it turns more expensive (for every dollar, you need to pay more in rupee now). More expensive goods (due to lower volumes of imports) fuel inflation.

How does the stand of MPC impact markets and investors?

Markets want to know the timeframe that the RBI would propose to bring inflation within the target band. After 190 basis points worth of rate hikes since May, investors are monitoring how much more the RBI could tighten the monetary policy.

One basis point is a hundredth of a percentage point. While the rate hikes are par for the course, inflation so far has not shown signs of abating. The RBI expects the softening to happen by the first quarter of the next fiscal, much as that is only an expectation as of now, pending an evolving scenario.

Will rate hikes be discussed at the ’emergency’ MPC meeting?

Not likely at the 3 November meeting, but the RBI might hike rates on the back of an expected 75-basis-point US rate hike on 2 November. “The unscheduled meeting on 3 November 2022 recently announced is only a part of the regulatory obligation,” the chief economic adviser at the State Bank of India, Soumya Kanti Ghosh, wrote in a note.

“We do not believe any other agenda to be announced at this meeting, against the market expectation of a slim chance of rate hike.”

The MPC had previously revised the rates at two unscheduled meetings, including a rate cut in 2020 during the pandemic and a rate rise earlier this year to curb runaway inflation.

What happens to the next, regular meeting in December?

Analysts do not foresee a change in the meetings scheduled for the rest of the year. They predict at least a couple of rate rises further before the end of the current tightening cycle.

This is the first time since the inception of the MPC in 2016 that the panel is failing on its inflation mandate. Hence, it will be key to watch how the government responds to the central bank’s arguments.

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