CPI inflation at 5.77% should ring alarm bells for new RBI governor


The retail inflation has been on an upward move in the last three months and has touched a 22-month high in June. The trend is worrying. It raises the disturbing question of whether the central bank is yet again beginning to fail a credibility battle on the inflation front, which it seemed to regain over a period of two-and-half years.
In June, the consumer price index (CPI) inflation rose to 5.77 percent compared with 5.76 percent in the preceding month. The CPI has been rising from April (5.47 percent compared with 4.83 percent). The current trend indicates that food and vegetable inflation continue to be the pain areas of inflation. Food inflation rose to 7.79 percent in June from 7.47 percent while that of veg inflation rose to 14.74 percent from 10.85 percent. Going ahead, the volatile food inflation will remain key to dictate the course of inflation.
The larger tend is worrying because under a formal agreement between the RBI and the government, if the inflation jumps beyond the 6 percent upper band, the RBI will have to explain to the government in writing why it failed to keep the figure within the limit (on the lower side, it is 2 percent). It is akin to the RBI’s credibility and its ability to manage inflation being questioned in public.
That’s an ignominy the central bank faced when the chief economic advisor’s mid-year economic analysis for 2014-15 made a scathing criticism on the RBI saying monetary policy lost its credibility between 2007 and 2013 on account of high inflation and hence negative real interest rates.
“India lost monetary policy credibility, reflected in the fact that real policy interest rates were consistently negative at a time when inflation was persistently in the double digit territory,” said the report.
Between September 2003 and September 2008 YV Reddy was the RBI governor. Reddy was succeeded by D Subbarao, whose term lasted until September 2013. Current governor Raghuram Rajan took over on 4 September 2013. From early 2014, the central bank began to regain control on the inflation battle. From double-digit levels in late 2013, the retail inflation was brought down consistently to below 6 percent levels since September 2014 i.e. one year after Rajan took over. Since then the highest point CPI inflation has reached is the last reading (June) at 5.77 percent, dangerously closer to the 6 percent upper target. This should ring alarm bells in the central bank and especially to the new RBI governor who will succeed Rajan.
There are also fears that central bank’s ability to control inflation itself is being undermined by the government for near-term growth and compromising on the inflation fight. As Rajeev Malik argues in the Mint, there is lack of clarity on inflation targeting ahead. There are some contradictions between the earlier government-RBI agreement and the recent amendment of RBI Act.
The recent RBI Act amendment doesn’t mention a target range for inflation but says the target will be revised once in every five years. As against this the existing agreement between the government and the RBI focus on a CPI target of 4% with a +/-2% band for financial year 2016-17 and all subsequent years. Already, the 2-6 percent range is much bigger among Inflation targeting Asian countries, Malik notes, citing examples of Indonesia (3-5 percent), the Philippines (2-4 percent), Thailand (1-4 percent) and South Korea (2 percent).
Governments tend to prioritise growth more than inflation since they always tend to take a short-term view. But, without sustainable low-inflation, growth wouldn’t mean much to the India’s poor. Beyond theory, the higher prices of essential food and vegetable items are already hurting India’s poor. Here the problem is more on account of more supply shortage not high interest rates. The government will have to work out ways to increase production, prevent hoarding and think on use of innovative technology to enhance the efficiency of cultivation given that land area isn’t increasing.
Merely pushing the RBI to settle for a higher inflation target and use that as an excuse to cut interest rates more will be beneficial for n ear term growth but disastrous for the economy in the long term.
The point is at no cost should the government dilute/ revise the inflation targeting as currently pursued by the central bank (5 percent by early 2017 and 4 per cent by 2018). Such a revision will be a huge negative for the economy and will reverse the gains of a hard-fought inflation battle. Much will depend upon the structure of the new Joint Monetary Policy Committee (MPC).
The government can easily influence the structure by filling it with people it considers will favor its interests. If the new RBI governor too sides with idea of watering down the inflation battle to appease the government, that can prove disastrous for the economy in the long-term as people will have to live with high prices for a long time. The government should, in turn, look for ways to control inflation by addressing the core problem (supply constraints) and not force the central bank toe its line.

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