Reserve Bank of India (RBI) Governor Shaktikanta Das is right in not wanting a review of the 4% inflation target even if six years have passed since India rolled out a framework to rein in consumer prices. Changing the targets might, as Das has observed, make the central banks a little less committed to taming inflation at a time when the runaway rise in retail prices the world over has hit consumers badly. In India, the debate comes against the backdrop of some serious inflationary pressures—measured year-on-year, consumer inflation has come in above the 6% tolerance limit in every month between January and October. As required by the law, RBI has written to the government explaining the reasons for the overshoot.
The fact is that inflation forecasts are becoming increasingly difficult to make given disrupting events like the Russia-Ukraine hostilities that caused prices of several commodities to spike. The US Federal Reserve believed until late last year that the price rise in the US was transitory, acknowledging only in December that inflation was turning out to be more persistent than expected. That was even before the Russia-Ukraine war sent commodity prices soaring. As RBI pointed out in early June, a good part of the rise in inflation forecasts can be traced to a series of supply shocks linked to the Russia-Ukraine hostilities. Moreover, the risk of inflation staying up remained, it said, for a number of reasons, not least of all elevated crude oil prices. In fact, with the rupee depreciating, all imported products have become more expensive and threaten to become costlier. With the second-order effects, through rising wages and salaries, the risks aren’t reined in just yet. The world is living in not just a highly inflationary environment but one in which the price rise is sticky. Also, given that there has been no de-escalation of geopolitical tensions, it is unclear how prices will move over the next year or so.
Nonetheless, even if inflation stays above the 6% ceiling, which is very likely in the near term, it is important to leave the framework intact. To many, making RBI “accountable” for keeping a leash on inflation is unfair since there are many factors beyond its control, which impact prices. Importantly, food and beverages, which account for a weight of nearly 46% in the CPI, have been a big factor in driving up inflation. RBI had observed in June that around 75% of the increase in inflation projections could be attributed to the food group. In this area, RBI is entirely dependent on government measures. The government has taken steps to tame food prices; for instance, the effective import duty on crude and refined palm oil has been lowered from 30.25% and 41.25% to 5.5% and 13.75%, respectively. The reduction in excise duties on petrol and diesel have also helped dampen inflationary pressures. Indeed, as the recent inflation is more a supply-side phenomenon rather than one driven by demand, the efficacy of monetary policy would be limited. At a time when the economy is still recovering from the effects of the pandemic, RBI has done well to pace the rate hikes. The central bank must fight inflation while looking out for growth, but it should be given the necessary room to fulfil this mandate in what is an extremely difficult environment.