MC Explains | Five questions answered as RBI rate-setting panel meets today

As per the data, retail inflation rose to 7.41 percent in September, confirming that average inflation had stayed outside the 2-6 percent band for three consecutive quarters. Inflation averaged 6.3 percent in January-March, 7.3 percent in April-June, and 7 percent in July-September.

The RBI targets inflation at 4 percent within a tolerance band of two percentage points on either side of the target. The September inflation print meant inflation had spent 36 consecutive months - or three full years - above the medium-term target of 4 percent.

“As per the mandate, the RBI has to give remedial actions and possible time frame to bring down the inflation within the mandate,” said Soumyajit Niyogi, director – core analytical group at India Ratings and Research. “Since the policy rate is decided by the MPC, it is necessary to discuss the detailing with the panel as per section 45ZN.”

Also read: Policy rate likely to peak by January-March quarter as MPC shifts focus to growth, say economists

2. What is section 45ZN?

The central bank gets the power to announce an unscheduled meeting of the MPC under Section 45ZN of the RBI Act. This section, titled ‘Failure to maintain inflation target’, lays out what the RBI must detail in its report to the government following failure.

Further, as per Regulation 7 of the Reserve Bank of India Monetary Policy Committee and Monetary Policy Process Regulations, 2016, the secretary of the MPC must schedule a separate meeting of the committee “to discuss and draft the report to be sent to the Central Government under the provisions of Section 45ZN of the Act.”

The aforementioned regulation also says the post-failure report must be sent to the government within one month from the date on which the RBI has failed to meet the inflation target.

As the CPI data for September, which confirmed the RBI’s failure, was released on October 12, the report must be submitted by November 12.

3. What reasons will RBI give for failure?

The report will likely point to a variety of reasons to explain why the RBI failed.

"The reasons will be…you can't prevent the Russia-Ukraine war. It (the report) will talk about supply disruptions and the zero-COVID policy in China. The RBI will say this is why it failed," a person familiar with the developments had told Moneycontrol in May once it started to be apparent that the central bank would likely fail.

While inflation was already elevated prior to Russia’s invasion of Ukraine in late February, the resultant supply disruptions – especially with regard to cereals and energy-related commodities – further added to the problem.

4. What remedial action could the report suggest?

The RBI and the MPC have been tightening monetary policy for more than half a year now and the report is likely to highlight the steps it has already taken.

On April 8, the central bank announced the introduction of the standing deposit facility (SDF) to absorb excess banking system liquidity. This uncollateralised facility came with an interest rate of 3.75 percent, which immediately helped lift overnight rates.

The policy repo rate — or the rate at which the RBI lends funds to banks — has also been hiked by the MPC by 190 basis points since then to 5.9 percent.

One basis point equals one-hundredth of a percentage point.

Could the RBI indicate in its report that it may need to raise the repo rate further to bring inflation down to target? We don’t know and may not find out at all, as RBI Governor Shaktikanta Das had said on September 30 that the report was “privileged communication” and would not be made public, at least by the central bank.

However, economists expect the MPC to hike the repo rate by at least 35 bps at the December 5-7 meeting, with a possible terminal repo rate of around 6.5 percent, likely to be achieved by March.

“It is possible that the unscheduled meeting is solely set to respond to the government for missing the inflation target,” said Madhavi Arora, lead economist at Emkay Global Financial Services. “However, the fact that it’s kept just after the US Federal Reserve’s November 2 meeting makes it a tad tricky to guess if it's just going to be a draft response meeting to the government or can have some 'action' too.”

Also read: Road ahead for RBI: From framing monetary policy to failure in inflation check

5. When will inflation return to target?

For some time now, RBI officials have mentioned how two years is an appropriate period of time for inflation to be lowered to 4 percent. Even in the post-policy press conference on September 30, Governor Das had said the RBI expected inflation to "come down close to the target over a two-year cycle; that was our expectation earlier and even now."

As such, a two-year horizon from the report’s submission would mean inflation should be around the 4 percent target by the third quarter of FY25.

As per the RBI's latest inflation forecast, CPI inflation may average 5.2 percent in FY24 – 150 bps lower than the average of 6.7 percent projected for the current financial year.