Why Reserve Bank of India is struggling and unable to control retail inflation?

Introduction

The average annual Consumer price index (CPI) during year 2019, 2020, 2021 and 2022 was 3.7%, 6.6%, 5.1% and 6.7% respectively. Evaluation of last 4 years average annual retail inflation data points out that the retail inflation is quite high. The RBI is facing problem in controlling inflation as RBI is unable to understand the real issues behind the inflation. In this article those issues will be discussed which RBI should consider in future before finalizing monetary policy for better growth and development of the country. 

The Reserve Bank of India (RBI) on Wednesday, 8^th February 2023 hiked the key policy rate, the Repo rate or the rate at which the RBI lends funds to banks, by 25 basis points to 6.50 per cent. The RBI still considers retail inflation level quite high. Consumer price index (CPI) headline inflation moderated to 5.7 per cent (y-o-y) in December 2022 (Figure 1). Inflationary pressures accentuated across cereals, protein-based food items and spices. Fuel inflation edged up primarily from an uptick in kerosene prices. Core CPI (i.e., CPI excluding food and fuel) inflation rose to 6.1 per cent in December due to sustained price pressures in health, education and personal care and effects. So the repo rate increase was in consonance with the RBI’s objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. This decision is expected to make all repo rate based benchmark loans costlier immediately. Lending rates of banks are expected to go up as the cost of funds is expected to rise further. As much as 43.6 per cent of the total loans are now linked to the Repo rate. Marginal cost of funds-based lending rates (MCLR), which accounts for 49.2 per cent of the loans portfolio of banks, are also expected to move up. 

 

Consumer Price Index Numbers on Base 2012 100 for Rural Urban and Combined for the Month of December 2022.

Fundamental issues from CPI data

The fundamental issue behind the higher consumer price index (CPI) is systemic as majority of the components of the CPI like cereals, meat, fish, egg, milk, spices, prepared meals, snacks, sweets, clothing, footwear, fuel and light, household goods and services, health, education, personal care and effects etc. all are above RBI’s threshold of 4% as shown in Figure1 above. Only few components are below RBI’s threshold of 4% like oils and fats, fruits, vegetables, pulses, sugar, pan and tobacco.

India is a highest producer of milk in the world and even though the milk and its products inflation rate is 8.51%. Majority of food products are domestically produced in India and the Government also took the subsidy burden of the fertilizer, a key ingredient in agriculture food production, so the global price interference cannot be a sound reason behind the higher CPI in India.

 

And this fundamental systemic issue arises after Corona pandemic which disrupted consumption hampering demand with loss of jobs after closing of individual, small and medium enterprises, layoffs in large organizations to survive themselves. Later on some more interference were made by some international issues. Decrease in demand forced companies to increase their product prices, to survive, and this happened all across the sectors. This is the reasons why GST collections, as it is levied on percentage basis, decreased only slightly from about 12 lakh crore in 2019-2020 to about 11 lakh crore in 2020-2021 even during corona pandemic. The GST collections were reached to about 14 lakh crore in 2021-2022. During this government has also revised GST many times and has brought more products into GST regime. 

 

So when products prices are raising and GST’s are further adding to rise in prices, it is obvious that RBI will be failed to control inflation. So it is a more of the government’s responsibility to involve and intervene through policy and programs. RBI just only can intervene in those sectors in which excess credit is causing inflation. In those cases increasing interest rates is reasonable to slow down those excess credit intakes. A simple example is of automobile sector. If excess loan based purchasing of automobiles are causing and contributing in inflation then rise in interest rates can help to slow down it. But if RBI may think that higher inflation due to higher prices of potato, tomato and onion may be controlled by increasing interest rates then it will not work. Instead RBI should tell government to manage demand-supply equation through their own policy and programs.

Suggestions for RBI for inflation management

1. RBI should distinguish first and determine which components prices are increasing due to credit liquidity from inflation data.

2. Then RBI can increase interest rates for those sectors instead of a blanket rise based approach.

3. Those components, whose prices are not due to credit liquidity, should be acknowledged to the Government to look into the mater from their supply-demand equilibrium.

4. Government will look into the supply-demand equilibrium of identified components.

5. Government will investigate whether a price rise is due to natural causes or artificial causes like hoarding. Accordingly Government will make policy and programs to manage the inflation in short term as well as long term.