HYDERABAD: Core inflation in January continued to breach the upper tolerance inflation target band of 6 per cent. This begs the question if the central bank is missing the forest for the trees, once again?
In the not-too-distant past, when the monetary policy was guided by Wholesale Price Index (WPI), the RBI grossly ignored the underlying risks in rising food prices. For instance, in 2009, the food index rose by a staggering 15 per cent even when WPI (then the official inflation gauge) stood at 4 per cent. The rise in food prices were beguilingly pulled down by non-food manufactured products inflation, which was close to zero! Subsequently, in 2010, when food inflation became generalised, WPI picked up, including non-food products.
“By the time there was a policy reaction in March 2010, it was too late. Between 2009 and 2012, inflation averaged 10.4 per cent measured by the CPI-IW and 7.4 per cent by WPI and saw 13 policy rate increases failed to excoriate it. Entrenched now in the system, it began to mutate like a multi-headed Hydra,” noted Dr Michael Debabrata Patra, executive director, RBI, in a speech delivered in November 2017.
In the subsequent years, as inflation outcomes and expectations climbed, the real rate of return on bank deposits turned negative, forcing consumers to stock up gold. But its impact was felt on the current account deficit, which touched an alarming 6.8 per cent of GDP during the third quarter of FY13.
Making matters worse, the US Federal Reserve announced its balance sheet normalisation programme, leading to a capital flight as foreign investors lost faith in emerging economies including India, which fell into a new epithet — the fragile five. “What started out as a dose of food inflation eventually morphed into a balance of payments crisis. Monetary policy was subjected to its most severe challenge — the evaporation of credibility,” Patra recalled.
Circa FY19. Agreed food prices aren’t under stress and are showing signs of disinflation, but it’s important to remember that with unpredictable monsoon, upside risks are often round the corner. Also, this time around, trouble seems to be coming from core inflation, which remained elevated at about 6 per cent all through 2018.
Still, the distinguished Monetary Policy Committee (MPC) last week took comfort in its legislative mandate of retail inflation, which stood at 2.2 per cent in December 2018 and reduced key policy rates by 25 bps after weighing underlying risks. But is the MPC treading the right path? Only time will tell.