There is a lot of talk on inflation and the inability of Monetary Policy Committee (MPC) to tackle the price rise. Inflation isn't just another jargon in macroeconomics, it has a direct impact in the lives of common man. Let’s try to understand the issue in this column.
To begin with, who sets interest rates in India?
Prior to the creation of the MPC in 2016, the Reserve Bank of India (RBI) was the sole authority in setting interest rates in the country. The RBI governor - the top boss at the central bank - used to get inputs from his colleagues across departments and arrive at a rate decision.
Broadly speaking, the monetary policy used to be a one-man show.
But, this changed with the MPC coming into place in 2016. The process became more collaborative, including external members.
A first:
If the MPC writes a letter to the government on inflation management failure, it will be for the first time since its creation. The inflation target given to the panel for 2021-2026 is 4 percent with 2 percent on either side, thus effectively making a 2-6 percent band.
If the inflation averages above 6 percent for three consecutive quarters, it will be deemed as a failure. Two quarters have already gone by with inflation above 6 percent. The retail inflation stayed at 6.34 percent in the March quarter and 7.28 percent in the June quarter. The September quarter inflation is forecast to be around 7.1 percent, which means the three quarters will be complete.
So, what happens now? The MPC will have to meet soon to draft its response to the government. The letter will give reasons on what led to the failure in meeting the target and what are the ways to bring back the inflation within the target level.
What are the likely explanations? Most likely, the rate-setting panel will cite external factors that are beyond its control as the reason for inability to check inflation as well as growth concerns. Also, it is likely to ask for time to bring inflation back to the target band. As per the RBI’s own estimates, retail inflation will fall to 5 percent by the April-June quarter of the next financial year.
It is up to the government to accept the MPC’s proposal or not. To be frank, we don’t have a precedent for such a scenario, hence will need to wait and watch.
Now, coming to the most important part, what does all these mean for the common man? The MPC’s admission of failure on inflation fight should worry the consumers because this means that there is no immediate solution, even with the mighty monetary policy authority, to control the spiralling prices.
The MPC has only one big tool to control a supply-side inflation or inflation caused by higher prices of commodities or other raw materials - interest rates. The MPC can only make the cost of money more or less to control demand in the economy. But, current round of inflation isn't triggered by domestic factors. That will partly explain the current situation the MPC is in.
(To watch a full video discussion on impact of MPC's inflation failure on common man please click here)
What does all this means to you and me? For the common man, the impact of high inflation is palpable in his daily finances. Cost of goods and services have risen exponentially in the last few years, whereas income levels haven’t. High job losses add to the woes. The MPC’s official acknowledgment of inflation failure will only be a reminder of the pain that the country is going through.
(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)
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