Banking Central | RBI played ‘Dhritarashtra’, not Arjuna, on inflation for too long

In total, the repo rate has been increased by 225 basis points (bps) since May by India’s monetary policy committee (MPC). One bps is one hundredth of a percentage point. The central bank hiked repo by 40 bps in May, followed by three 50 bps rate hike each and, by 35 bps last week. Why did it do so? That’s because interest rate hikes are the only powerful tool with a central bank to control inflation, when prices are zooming beyond control. In fact, the RBI made a mistake for a while in the post-pandemic phase to support growth. It let inflation spiral, hoping that price rise will eventually end and by that time the economy will get a window of low interest rates and easy money to get back into the trajectory of high economic growth.

But in reality, inflation surprised everyone on the upside staying above the central bank’s 6 percent upper band for three consecutive quarters ending March, June and September. That meant the biggest embarrassment for the MPC as it had to publicly admit the failure in inflation management before the government through a formal letter. This acted as an eye-opener for the central bank and the rate setting panel. Thus, back-to-back rate hikes started. And the rate hikes aren’t over yet. The RBI has clearly indicted to the markets—by holding on to the current accommodative stance—that it will hike rates again soon. Question is when and how much. While the central bank believes that ‘worst of inflation is behind us’ , in the same breath it cautions that the fight against inflation is far from over. The Governor repeated his now famous phrase that the central bank has got ‘Arjuna’s eye’ on inflation. But, the fact is the central bank acted on inflation too late. Inflation started to rise above the central bank’s target of 4 percent long ago which was ignored for a prolonged period.

In an interview with Moneycontrol on May 30, former chief statistician of India Pronab Sen said the RBI should have been thinking about inflation at least six months earlier. While global prices have been going up, which is outside central bank’s control, there was a need to make sure that this important price increase didn't feed into a national pricing process, said Sen. There are other economists too who have pointed out RBI’s delayed battle on inflation. Had RBI identified the dangerous trajectory of inflation in advance, it could have talked to government about the dilemma and started the rate tightening process in small doses without having to go for back-to-back rate hikes in the end. Inflation has stayed above the desired target level from early 2020 and above 6 percent for nearly an year. Global factors played a role in inflation spike but the writing was on the wall already. The logic that growth would have taken a hit by early action on inflation is not convincing enough. High inflation has been hurting the common man more. Prices of essential items, including food and vegetables have shot up significantly raising questions on timely action from the Government and the central bank. Merely blaming the global factors wouldn’t help.

The RBI has woken up to the reality too late that inflation has gone far beyond its control.

There was caution within the MPC as well. In March this year, MPC member Jayant Varma said  an extended accommodative stance weakens the credibility of the MPC’s inflation-fighting credentials by giving a possibly mistaken impression that the MPC is not sufficiently concerned about inflation. If credibility is diminished, then the MPC might have to take more drastic and painful measures to have the desired impact on inflation, Varma warned. No one listened.

The truth is that RBI played the role of the blind king ‘Dhritarashtra’ on inflation for too long before the master archer ‘Arjuna’ entered the scene and finally got his eyes on the target. That explains the last minute panic rate hikes.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)