View: The RBI is running out of runway

At 7.41 percent in September, inflation is stubbornly above the central bank’s comfort level of 4 percent (+/- 200 bps) for the ninth month in a row. Three-quarters of failing to bring inflation back within its comfort level means the Monetary Policy Committee has to explain itself to Parliament, and detail future measures it plans to take to get inflation back in control. Writing this letter will certainly not be easy; simplistically, put, it will probably be akin to writing to tell your parents you failed that semester-end math test.

It's not that the RBI did not taste some initial success. Retail inflation retreated from 7.9 percent in April to 6.71 percent in July. But the retreat seems to have been short-lived, at least for now. In the 3 months since July, inflation has risen gradually -- first to 7 percent in August, and then to 7.41 percent in September. So for the battle-weary Reserve Bank, the letter to Parliament will have to enumerate a stratagem that goes beyond rate hikes.

The rise in inflationary pressures cannot be laid at the feet of rising food and fuel prices alone. Core inflation, which excludes these volatile items, has also tracked the overall trend – rising from 5.8 percent in July to 5.9 percent in August and further to 6.1 percent in September.

A lot of this rise in prices has been attributed to imported inflation: to global supply-chain disruptions that linger from the global lockdowns effected during the COVID-19 pandemic, to the spillover effects of Russia’s invasion of Ukraine, to the Indian Rupee’s 10 percent depreciation this year against the dollar, which means importers have to pay more for the goods and services they bring in. The base effect argument also offers some cover. But base effects are not eternal, sucker punches from external shocks will still make the nose bleed -- and nosebleeds are notorious for lasting a while.

So too, the external threats themselves. Russia's President Putin is unfazed by the bluster and chest-thumping show being put on by much of Europe and the USA and has resorted to nuclear threats to ensure his invasion of Ukraine is not checked. China remains obstinate in its desire to wipe out the COVID-19 virus through prolonged lockdowns, despite the detrimental effect this may have on its own economy. And now, fresh sanctions on Iran could rock the ship that's already bobbing on oily waters.

Meanwhile, India’s forex reserves have been falling as the RBI tries to offer the domestic currency a parachute, and economic activity has been slowing down (though some pockets of the industry point to a bit of a revival over the festival season). The question, of course, is what happens once the festival season winds down, and the rest of next year stretches ahead? Or worse, what if the festival season is not as full of good cheer as people would like it to be?

This puts the RBI on something of a back-foot because any more aggressive rate action could let the wind out of the economy’s sails further, and poke holes in the narrative that the India story is still building up the tempo, and not heading to an anti-climactic end. Further rate hikes will put India’s aspirations of hitting GDP growth levels above 7.5 percent in jeopardy and substantively delay the engines that have been set on course for an ambitious $5 trillion economy.

This will need some out-of-the-box thinking – a nimble and delicate pressing into service of the other weapons and ammo in the RBI’s arsenal within a fairly small window, and it will have to act without appearing to seem hasty or desperate. Because perception matters.

Granted, India's position with inflation is not as bad as the USA's, where retail inflation stood at 8.3 percent in August against the US Federal Reserve's comfort level of 2 percent, and further rate hikes to bring it down could nudge the American economy into a recession. But nor does India have the luxury of taking it easy, since the engines that power the American economy run on very different fuel.

One big pressure point for the RBI is that a reiteration of past successes will not hold water. Whether the RBI has been ahead of the curve so far, or whether the various administrative machinery have been instrumental in keeping the Indian economy insulated from external shocks to such an extent that things are not as bad as they could have been, will mean little. That rate hikes today will show results with a 3-month delay may not be a good enough answer either, since fresh body blows, either imported or home-grown, cannot be ruled out.

Could desperation to show palpable results against inflation prompt more aggressive rate action? Quite probably. Could India be looking at a prolonged battle against inflation that causes more wounds and leaves scars? Not beyond the realm of possibility. Can RBI sacrifice a little more growth at the altar of inflation control? It may not have much of a choice.

I don’t envy the RBI Governor at this exact moment.