How RBI failed to manage inflation?

On Wednesday, RBI governor ShaktiKanta Das announced an increase in Repo rate by 40 bps from 4 to 4.40% (basic points) and cash reserve rate (CRR) by 50 bps from 5 to 5.50%. This action was taken to bring down the elevated interest rate and to tackle the impact of geopolitical tensions the country. Repo rate is essentially the rate the at which the RBI lends money to banks. The hike in repo rate means the cost of borrowing for banks from RBI will rise causing changes in consumption and demand. RBI seeks to increase the incentive for people to save more and spend less thus reducing the aggregate demand in the economy. CRR is the percentage of the depositor’s money which is mandatory for the commercial banks to submit to the RBI. Usually if liquidity being to be infused into the economy, the RBI will reduce the CRR which leaves banks with more money to lend to the public. But on the other hand, a rise in CRR will result in reduction of liquidity from the system. The 50-bps rise is expected to remove about 87000 crores from the banking system.

This meeting was unexpected because Monetary Policy Committee (MPC) usually meet once in two months and after meeting in April, the next meeting was set in June and less than a month ago, when the MPC met, they decided to keep the rates unchanged. Although a change was much awaited as the central bank could be seen struggling to control inflation and maintain price stability. RBI has really been underestimating the effect and consequences of inflation which can be observed thorough the following indicators -:

· Inflation has been rising for the past two years now.

The law instructs the RBI to keep the retail inflation close to 4%. However, there is a leverage given of 2% on either side. This means that the government is required to keep the inflation between 2%-6%. But this doesn’t mean that the inflation stays close to 6% most of the time. It must be always kept at close to 4%. The graph below shows that inflation is only even close to 4% in only one month. Most of the time is inflation is close to 6% and even over 6% a few times. RBI can clearly be seen neglecting their responsibility of keeping inflation in control.

· Inflation has not been momentary.

In causes of high inflation rates have been changing throughout the year: sometimes the inflation is fuelled by high crude oil prices and otherwise by food scarcity caused by unseasonal rains. Overall, the inflation rate has remained high. Since November 2019, boosting the economy has been the focus of the government even if it means permanently high inflation rates. This approach is bruising the poor midst an economic downturn which is fleecing millions. of their earnings & savings.

· The rise in global crude oil is not recent.

One of the key reasons given for high inflation rate in India was the rise in crude oil prices due to the outbreak of a war between Ukraine and Russia. But RBI was aware of this increase when the MPC met for their previous review in February when they boldly released a statement that the inflation rate will be close to 4.5% in the coming year. (The inflation rate has been well over 4.5% since November 2021).

· High core inflation is not new either.

Core inflation is essentially the inflation rate stripped off the effect of fuel and food prices. RBI stated that core inflation is to remain high for the coming months depicting high domestic prices of medicines. Evidence shows that since last year, the core inflation rate had started its upward journey. Since the highly fluctuating prices of food and duel are stripped off core inflation, it tends to rise and fall slowly which is a cause for concern.

· RBI waited too long.

A common stream if thinking is that as soon as a change is made in the monetary policy or once RBI makes changes to the interest rates, the economy will start to see instant results. But there is a time gap between the implementation of these policies and seeing results. If RBI took inflation seriously and wanted to change the prevailing rates, it should have taken actions early in the year during the month of February. Taking a decision now and raising the rates now will not result in immediate visibility of results.

Although inflation has finally come to the RBI’s attention blinding themselves and postponing the necessary under the name of boosting development was not a very helpful decision for the economy.