Why India’s central bank took so long to acknowledge country’s rising inflation

You scratch my back and I’ll scratch yours
You scratch my back and I’ll scratch yours
Image: REUTERS/Anushree Fadnavis
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The Reserve Bank of India (RBI) had apparently been trying to underplay inflation for the government’s benefit.

A three-part investigative report by The Reporters’ Collective and Al Jazeera, this week, showed that the RBI may have used an unwritten “escape clause” to avoid treating its inability to rein in price rise as “failure.”

The government has played along because the central bank would otherwise be forced to hike interest rates, making its market borrowings more expensive and worsening things for India’s wobbly economy.

The Indian government has officially set a target of 4% for inflation for the RBI, but with a tolerance band of two percentage points. In only five out of the 22 months since November 2019 have consumer prices remained close to that target. This year, they have even breached the upper limit of the 2%-6% tolerance band—in January (6.01%) and February (6.07%).

Consumer prices in India are expected to continue rising.

The RBI finally acknowledged the risk of inflation today (April 8) in its monetary policy statement. It revised its inflation forecast to 5.7% for the ongoing financial year from 4.5% projected in February.

“A combination of high international commodity prices and elevated logistic disruptions could aggravate input costs across agriculture,
manufacturing, and services sectors. Their pass-through to retail prices, therefore, warrants continuous monitoring and proactive supply management,” governor Shaktikanta Das said in his statement (pdf) today.

Assuming crude oil prices average around $100 per barrel in 2022-23, the RBI downgraded its estimate for India’s real GDP growth—an “overarching priority”—to 7.2% for the fiscal year, compared to its earlier guidance of 7.8%.

The quarterly projections were sharply revised to 16.2% for April-June 2022, 6.2% for July-September 2022, 4.1% for October-December 2022, and 4% for January-March 2023.

RBI’s escape from accountability

The Indian law allows the RBI to miss its inflation target for three consecutive quarters before qualifying it as a “failure.” Under Das, it missed the target in January-March 2020, April-June 2020, and July-September 2020.

The RBI’s monetary policy committee (MPC), however, discarded the inflation data for April and May 2020. It said the national lockdown had led policymakers to use a different methodology to arrive at the inflation figure, rendering the estimates “unrealistic.”

“But, records show, these numbers had been endorsed at all levels of the government and its statistical agencies and had been used by the government for all other economic assessments,” Al Jazeera reported.

Under Indian law, on failure to meet the inflation target for three consecutive quarters, the RBI is required to write to the government within a month explaining the cause, along with a corrective plan. “This transparency is required to prevent businesses and citizens from losing faith in the RBI and the government’s ability to rein in inflation,” the report said.

The country’s finance ministry, however, gave the RBI leeway. It reportedly decided that such accountability will be applicable only from the quarter beginning July 2020.

This was allegedly out of fear that the RBI would hike rates to control inflation, making market borrowings costlier at a time when the economy was already struggling. The Indian government plans to borrow 14.95 lakh crore rupees (nearly $200 billion) in the fiscal year ending 2023 to fund its revenue gap.

Sovereign debt management

While the RBI’s mandate is to maintain price stability with a view on growth, governor Shaktikanta Das has made it clear that growth was “the overarching priority” at this stage.

The RBI’s monetary policy stance differs from those of other global central banks. Besides the US Federal Reserve and the Bank of England, central banks of even emerging market countries like Brazil, South Africa, and Russia have been making price stability their priority.

Under Das, the RBI has reduced the repo rate—at which banks borrow from it—by a record 135 basis points (100 basis points equals 1 percentage point) between February 2019 and February 2020. During the pandemic, despite high inflation, the repo rate was further slashed by 115 basis points to an all-time low of 4%.

Lower rates make borrowing money cheaper. This encourages consumers and businesses to spend and invest more. Lowering rates, however, also leads to rising consumer prices.

Das hinted at prolonged policy support and doing “whatever is necessary” to support growth.

RBI’s credibility may have taken a hit

The RBI’s current inflation stance may have eroded its credibility.

“They should have written the letter, pointing to the exceptional circumstances that prevailed from March 2020, and arguing that this technical ‘failure” was, in fact, a modest success,” Williem Buiter, adjunct professor of international and public affairs at Columbia University, told Al Jazeera.

On March 22, Das ruled out the possibility of inflation staying above 6% for long. He argued, instead, that withdrawal of the policy of support will be counterproductive.

Buiter, however, believes otherwise.

“It is time to recognise that this inflation is not transitory or temporary, that it is not driven by short-live supply shocks and increases in global fossil fuel prices that are unlikely to be repeated,” he said.

The RBI must raise policy rates now, Buiter said.