*Why MPC should explain its failure to contain inflation to Parliament, not to govt – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/why-mpc-should-explain-its-failure-to-contain-inflation-to-parliament-not-to-govt/articleshow/92638897.cms


“The Reserve Bank of India may have multiple goals. But Monetary Policy Committee has only one — inflation control. So why did it abdicate this responsibility?”

The economy has barely recovered from the impact of the pandemic. It should be ensured that there is no ‘intolerable growth sacrifice’ in attempts to tame inflation ‘too abruptly’. Those were RBI‘s Monetary Policy Committee (MPC) member Jayanth R Varma’s words in late June. Other members have expressed similar views in defence of the MPC‘s failure to tackle inflation in time.

‘Intolerable growth sacrifice’? ‘Too abruptly’? What do these words mean? More importantly, is it for an unelected technical body to decide what is ‘intolerable’? Or is it for the people of the country – their elected representatives – to decide? More so when it comes to something as critical as inflation. Presumably, the latter. Hence the decision to enshrine inflation targeting in law, by way of an amendment to the RBI Act, 2016.

The Elusive Number
But things have not panned out as envisaged. The shift to inflation targeting entailed three critical changes:

  • A shift to a transparent, well-defined inflation target (4% +/-2%).
  • Responsibility for achieving this target and, in tandem, transfer of rate action to an MPC, rather than left to the RBI governor.
  • Accountability for failure to achieve the target was fixed.

Sadly, it is on this last count that MPC has failed. India’s wholesale price inflation has been in double digits for 14 straight months. At 15.88%, inflation in May 2022 was the highest since September 1991 and came on a high base of the previous year, indicating the severity of underlying inflationary pressures. The story on the retail front is no better. Consumer price index (CPI) inflation was close to 8% in April 2022, nearly double RBI’s legally mandated target of 4%. May numbers showed a slight dip, but come on the back of a much higher base (6.3% in May 2021, against 4.3% in April 2021).

None of this is new, or unexpected. Unlike the West, where inflation is a relatively new phenomenon, we have lived with high inflation (barring some sporadic dips) for almost three years, starting December 2019. So, why did MPC fail in its job as inflation ‘watchdog’? Far from expressing dissent, why did external members go along with the line favoured by RBI – using monetary policy to support GoI’s borrowing programme, if necessary, by manipulating the yield curve?

RBI may have multiple goals. But MPC has only one – inflation control. So why did it abdicate this responsibility?

CPI inflation during March-December 2020 exceeded the 6% upper limit of RBI’s target band for three consecutive quarters. Under the RBI Act 1934 (amended in 2016), this is defined as ‘failure’ and requires the Bank to submit a written explanation to GoI explaining why it failed, suggest remedial actions and the period within which the target would be achieved. Yet, not only did the Bank fail to do this, but going by the minutes of MPC meetings, none of the external members questioned RBI for its failure to comply with the law.

In 2020, RBI dodged its obligation under law on the grounds that inflation numbers during Covid could not be relied on. However, it has shown no hesitation in using these very same numbers to argue that inflation fell in early 2021, conveniently ignoring the fact that low numbers were due to the base effect of the earlier discredited numbers.

No Cheers for 3 Quarters
All that is history. But with RBI now projecting inflation at 7.5%, 7.4% and 6.2% for the first three quarters of this fiscal, we are likely to see the inflation target breached for three consecutive quarters by September 2022. How can we ensure RBI does not evade its responsibility on flimsy technical grounds, as in 2020?

The Urjit Patel Committee report, which laid down the theoretical framework of inflation targeting, suggested MPC be ‘accountable for failure to establish and achieve the nominal anchor’. ‘Failure’ was defined as the inability to achieve the inflation target of 4% (+/-2%) for three successive quarters.Such failure will require the MPC to issue a public statement, signed by each member, stating the reason(s) for failure, remedial actions proposed, and the likely period of time over which inflation will return to the centre of the inflation target zone,’ it states.

This was watered down in the final legislation. In terms of Section 45ZN of the RBI Act, when the Bank fails to meet the inflation target, it ‘shall set out in a report to the Central Government (a) the reasons for failure to achieve the inflation target; (b) remedial actions proposed to be taken by the Bank; and (c) an estimate of the time-period within which the inflation target shall be achieved pursuant to timely implementation of proposed remedial actions’.

The Gazette of India (July 2017) says the secretary to the committee ‘shall schedule a separate meeting as part of the normal policy process to discuss and draft the report to be sent to the Central Government under the provisions of Section 45ZN of the Act. The Report shall be sent to the Central Government within one month from the date on which the Bank has failed to meet the inflation target.No report was sent in 2020, at least none that we know of. So, how can we ensure that come September, the report will see the light of day? Can we strengthen the most critical aspect of any legislation – accountability?

We can. By just amending the Act so that RBI is obliged to send its report to Parliament, not to GoI.

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