RBI's desperate catch-up act on inflation may hurt the economy

Representative image (File image: AP Photo)

India's retail inflation stayed largely unchanged at a high of 7.01 percent in June as against 7.04 percent in May, according to data shared by the government. The June CPI inflation print takes average inflation for April-June quarter to 7.3 percent. With inflation having already averaged to 6.3 percent in January-March, the RBI is now only one quarter away from failure. Former Governor D Subbarao said in an article written for Moneycontrol in May RBI may have to explain inflation target failure to government by September.

That is increasingly looking like a strong probability.

The central bank's primary mandate is to maintain stability. Yet, it let loose the inflation genie for too long, in search of a stimulus-led growth. It is now playing catch-up with steep, consecutive rate hikes. But raising rates too quickly will not bode well for Asia's third largest economy where recovery from pandemic is still fragile.

The MPC, which sets rates in India, obsessed with so-called accommodative stance for a considerably long time saying pandemic -induced slowdown needs closer policy attention, even at the risk of ignoring the near-term inflationary pressure. The panel probably thought high inflation will cool down on its own in due course. But this assumption was proved terribly wrong.

There were warning signals within the panel. Jayanth Varma, one of the three external members, constantly warned about the inability of monetary tools to control pandemic ill effects on Indian economy. Varma even warned the likely inaccuracies in MPC's forward guidance to markets could risk it's very credibility. But no one paid attention.

But Das and others realised the error in April. The tone of rate setters finally changed with clear acknowledgement of an alarmingly high inflation. And the party if easy money stopped in May when the panic-gripped MPC called an unscheduled meeting to decide 40 bps repo hike that followed another 50 bps in June. Inflation forecasts were upped sharply. Even the 90 bps hike looks like only the start of a prolonged rate hike cycle.

But a sudden surge in interest rates poses certain risks for Indian economy. It will hurt the faltering recovery, kill demand and even kickstart another stress-cycle. Already, borrowing costs for smaller and mid-sized companies have shot up by 200-250 bps compared with last year. High interest rates will dampen the demand for consumer loans, a safe haven for Indian banks hit by waves of corporate defaults. Soaring yields can also make Narendra Modi-government worried as Government borrowing will turn costly.

Yet, the choices before Das are limited. A persistently high Inflation, way above the MPC's Parliament-set mandate, is far big an embarrassment for him should the MPC is forced to publicly admit its inflation-management failure to Government. Much will dependent on inflation trajectory in the September quarter.