After months of waiting for the obvious, we can finally say that the Reserve Bank of India (RBI) has failed to meet its inflation mandate.
The release of the Consumer Price Index (CPI) data for September on October 12 confirmed average headline retail inflation has been out of the 2-6 percent tolerance range for three consecutive quarters – 6.3 percent in January-March, 7.3 percent in April-June, and 7 percent in July-September.
What happens next is clear: the RBI must submit a report to the central government detailing the reasons for failure, the remedial actions it proposes to take, and an estimate of the time period within which inflation will return to target.
To draft the report, the Monetary Policy Committee (MPC) must meet soon as the report has to be sent to the government within one month of the occurrence of failure, or by November 12. But what exactly will the report say?
Of the three aspects mentioned above, two are pretty clear – the reasons for failure and the time period within which the RBI hopes to return inflation to target.
"The reasons will be…you can't prevent the Russia-Ukraine war. It (the report) will talk of supply disruptions, the zero-COVID policy in China. The RBI will say this is why it failed," a person familiar with the developments had told Moneycontrol in May after it started becoming clear that the central bank would likely fail to meet its mandate.
It was in anticipation of an ugly April print that the MPC acted out of its meeting schedule and kick-started the rate hike cycle with a 40-basis-point increase in the repo rate on May 4.
The number did not disappoint, with CPI inflation surging to a 95-month high of 7.79 percent in April, data released on May 12 showed.
It is worth noting that Andrew Bailey, governor of the Bank of England, also mentioned the impact of the Russia-Ukraine war and supply shortages of certain key items such as semiconductors to explain why inflation had moved away from the 2 percent target in his March 17 letter to the then Chancellor of Exchequer, Rishi Sunak.
The second aspect of the report that is for all to see even now is the timeframe within which the RBI wants to bring inflation back to target. For some time now, RBI officials have mentioned how two years is an appropriate period of time for inflation to be lowered to 4 percent.
Even in the post-policy press conference on September 30, Governor Shaktikanta Das said the central bank expected inflation to "come down close to the target over a two-year cycle; that was our expectation earlier and even now."
There is little reason for the failure report to say anything different, especially with RBI's latest forecast pegging average CPI inflation for FY24 at 5.2 percent, a steep 150 basis points lower than the average of 6.7 percent for the current financial year.
What of the third aspect of the report?
Rising terminal rate?
The failure report must also detail the remedial actions the RBI proposes to take to bring inflation down to target. And here we are in the dark, for while the central bank has already taken some action – 190 basis points worth of it, to be precise – there is broad agreement among economists that more needs to be done.
One basis point is one-hundredth of a percentage point.
In fact, the slightly higher-than-expected September inflation figure of 7.41 percent, in combination with an aggressive US Federal Reserve, has perhaps pushed the terminal repo rate higher.
"With increased Fed rate hikes in 2022 and an adverse inflation forecast, RBI will have to walk a fine balance of rate hikes," Soumya Kanti Ghosh, State Bank of India's group chief economic adviser, noted on October 12.
"We are now looking at the terminal repo rate going higher than 6.5 percent," Ghosh added.
On the other hand, divisions within the MPC have become apparent thanks to the minutes of the September 28-30 meeting of the panel, released on October 14.
While it was already known that Ashima Goyal preferred a 35-basis-point increase in the repo rate on September 30 as opposed to the majority vote of 50 basis points, fellow external member Jayanth Varma explicitly said the MPC should now pause and wait for its actions to take effect.
The next four weeks or so are crucial then; not only must the RBI submit its report to the government by November 12, the October CPI inflation print will be released on November 14 and should influence what happens in the December 5-7 meeting of the MPC, with economists predicting a sharp drop-off to sub 6.5-percent levels.