Explainer| MPC fails in meeting inflation mandate: What happens next? 5 key points

Representative image.

The consumer price index- (CPI) based inflation has come in at 7.41 percent in September. With this, inflation has averaged 7 per cent in the July-September quarter. What does the latest inflation print mean to the rate-setting panel? Here are five key points.

The Monetary Policy Committee (MPC) has clearly failed in its mandate to contain inflation, something former Reserve Bank of India (RBI) governor D Subbarao had warned of in his column for Moneycontrol in May this year.

The MPC is tasked with confining inflation within a band of 4 to 6 per cent. If the average inflation stays above this level for three consecutive quarters, the MPC will have to write to the union government explaining the reasons for failing to meet its mandate, and the remedial action it proposes. This has come to pass now. CPI inflation averaged 6.3 percent in January-March, 7.3 percent in April-June, and 7 percent in July-September.

Failure to meet the mandate puts the MPC under pressure to act tough. This means that rate hikes aren’t over yet. High inflation in the September quarter confirms that it is too early for the RBI to soften its stance on rate hikes. At least a 50 basis points (bps) rate hike is certain in the near future. Though this could happen in smaller doses as well.

The MPC’s job becomes even tougher on the growth vs. inflation front. While it is certain that the MPC has to continue with rate hikes, a weak growth scenario presents fresh challenges to the rate-setting panel. Raising rates too quickly will have a counter effect on growth as creditors will be forced to pass on higher rates to the end borrower, thereby creating a drag on economic recovery.

The MPC’s failure marks a first in its six years of existence. In 2020, as Subbarao wrote in his column, a similar contingency was on the anvil but the inflation target was then suspended to circumvent the letter that had to be written, considering that the pandemic was an exceptional situation.

The MPC’s failure could be used as a political weapon by opposition parties to blame the ruling government on the price situation. High inflation is hurting every section of the economy, in turn putting political pressure on the government. The MPC too will feel the heat.

What do experts say? Most economists agree on further rate hikes ahead.

“Even though India’s inflation has peaked, it still warrants caution,” said Madhavi Arora, Lead Economist, Emkay Global Financial Services. “We still think the RBI would not turn too restrictive and the terminal rate would hover near estimated neutral real rates, implying ~50 bps hikes ahead. However, the extent of global disruption will remain key to the RBI’s response,” said Arora.

Rahul Bajoria, MD & Head of EM Asia (ex-China) Economics, Barclays seems to agree with this view.

“CPI inflation rose as expected in September, led by food prices, and October is also tracking above 6  percent. The RBI will struggle to pause its hike cycle if the CPI remains out of the target, making another rate hike likely in December,” said Bajoria.

The six-member MPC will have to meet soon to frame its response to the government on its failure to contain inflation