5 indicators that RBI dropped the ball on managing inflation
- At least five indicators show India's central bank fell behind the curve on managing inflation - glossing over mounting macroeconomic evidence and delaying important policy decision.
RBI and Inflation
RBI raised the repo rate or the rate at which the RBI lends money to commercial banks from 4% to 4.40%.
- By raising repo rate, RBI hopes to incentivise people to spend less and save more.
- It will cool down the demand in the economy and also control the prices.
Current Inflation Trends
Inflation has been rising for over two years almost continuously now.
- According to the law, the RBI is supposed to target retail inflation at 4%.
- The law prescribes some leeway to the RBI - it allows for retail inflation to vary by 2 percentage points on either side.
- RBI could allow inflation to be 2% or 6% in a particular month.
- During the nationwide Covid-19 lockdown in 2020, inflation stayed well above 4%, and often even above the 6% mark.
Continuous High Inflation
The inflation has remained high throughout the last year and remained high till date.
- Sometimes it has been fuelled by high crude oil prices as well as the high level of taxation on such fuels.
- Sometimes it has been kicked up by the scarcity of food articles, perhaps because of unseasonal rains.
- The RBI has very openly given first preference to boosting growth by keeping interest rates low instead of controlling inflation.
Inflation Spike due to High Crude Oil Price
RBI has pointed to high crude oil prices in the wake of the Ukraine war, as one of the key reasons for high inflation in India.
High Core Inflation also a factor
Core inflation is likely to remain elevated in the coming months, reflecting high domestic pump prices and pressures from prices of essential medicines.
- Evidence shows that as headline retail inflation moderated a bit, the core inflation had started going up.
- Core inflation going up is often more worrisome because it takes more time to both rise and fall.
- The prices of food and fuel tend to fluctuate a lot, while core inflation moves up or down slowly.
Ineffectiveness of the Monetary Policy
As soon as RBI raises or reduces interest rates, the economy will respond immediately.
- While “monetary policy transmission” has improved over the time, yet it can take weeks to have full effect.
- If the RBI wanted to contain inflation in May, it should have acted in February or at least in April.
- Raising rates right now may not bring down the inflation rate immediately.
- Monetary Policy
- Concept of Inflation
- Core and Headline Inflation
- Repo Rate and Base Rate
Q. What are the consequences of an ineffective monetary policy. Discuss how the RBI’s policy rates not only decides rates of banks lending facilities but also day to day inflation faced by a common citizen.