Failure this year, lower inflation next year – RBI thinking beyond 2022

"The forecasted CPI trajectory is consistent with the MPC failing on its inflation mandate," Choudhary said.

"…reading the policy document with its embedded forecasts probably provides some relief that the calibrated stance continues despite this 'fait accompli' and that RBI is looking beyond this now to January-March 2023 inflation and beyond," he added.

The RBI expects CPI inflation to fall to 5.8 percent in the first quarter of 2023.

Lagged effect

Why could the RBI be looking beyond 2022 and into next year? Because, it can't do much about the upcoming inflation prints.

"Monetary policy actions affect the economy with long lags, but these lags are also variable," said A Prasanna, Chief Economist at ICICI Securities Primary Dealership.

"So, it is reasonable to say today's actions are not going to have a material effect on the economy in the first three quarters of the fiscal. It is likely that there will be an impact by the last quarter of FY23. The impact will be clearly discernible in FY24," Prasanna added.

This bears out in the RBI's forecasts. Since the ongoing repo rate hikes ― totalling 90 bps so far in FY23 and more expected to come before the end of the year ― are unlikely to bring down inflation in the near term, the central bank raised its CPI inflation forecast for FY23 by 100 bps to 6.7 percent.

At the same time, the GDP growth forecast for the current financial year was retained at 7.2 percent – again indicating the RBI does not see its rate actions having an immediate adverse impact on growth.

Prasanna also pointed out the RBI's GDP growth forecast of 7.2 percent, when it was first announced in April, was lower than the market consensus.

"Since then, market estimates have been moving down. So, the RBI started off with a conservative growth forecast in April, and they are sticking to it, which is fair," he said.

Next year’s work

If the RBI can't avoid failure by raising rates now, the next best thing would be to ensure inflation comes down to acceptable levels as quickly as possible ― which is what the current rate hike cycle is likely trying to achieve.

"By hiking rates now, RBI and MPC are paving the way for inflation to come down next year. This would also be the argument of the RBI, that today's rate hikes are with an eye on lowering future inflation," Prasanna said.

The repo rate hikes announced so far ― and likely to be announced in the coming months ― may also help the RBI limit any damage from the 'letter' it will have to send to the government in case it fails to meet its mandate.

The law states that if the RBI fails to meet the inflation target, it must submit a report to the Centre ― commonly referred to as 'the letter' ― spelling out the reasons for failure, the remedial actions it proposes to take, and an estimate of the time period within which inflation will return to target.

Writing letters

If the RBI's latest inflation forecasts hold, it will be sending this letter to the government in October. And if the rate hikes announced by then indicate inflation could come down to the tolerance range fairly quickly without a lot more tightening, the contents of the letter may not be as stringent as it would be when it comes to the remedial actions proposed by the RBI.

In May, a person aware of the deliberations had told Moneycontrol that the RBI may have to resort to using a "sledgehammer plus sledgehammer" approach if inflation is to be brought back to mandated levels in a short period of time of around six months.

By as good as accepting that it is going to fail to meet its mandate this year, the RBI may have already started thumping its sledgehammer to spread out the impact over several months.

One failure isn't necessarily bad. Consistent failure, however, is. And the RBI will surely not want to fail on a consistent basis.