RBI teeters on the edge of failure as retail inflation scales back 7% level

India's headline retail inflation rate, as measured by the Consumer Price Index (CPI), returned to 7 percent territory in August from a five-month low of 6.71 percent in July, according to data released on September 12 by the Ministry of Statistics and Programme Implementation.

CPI inflation had fallen to 6.71 percent in July after spending three consecutive months above 7 percent.

At 7 percent, the August CPI inflation figure is slightly above the consensus estimate. As per a Moneycontrol poll, CPI inflation was seen rising to 6.9 percent.

CPI inflation has now spent 35 consecutive months above the Reserve Bank of India's (RBI) medium-term target of 4 percent and eight straight months outside the central bank's 2-6 percent tolerance range.

As such, the RBI is now on the brink of failing to meet its inflation mandate.

The RBI is deemed to have failed when average inflation is outside the 2-6 percent tolerance range for three consecutive quarters. Having averaged 6.3 percent in January-March and 7.3 percent in April-June, inflation must fall to at least 4.1 percent in September for the July-September average to come in under 6 percent and the RBI to avoid failure - an unlikely scenario.

The RBI's latest forecast says inflation will average 7.1 percent in July-September.

August CPI internals

While the index for cereals rose by 2.4 percent month-on-month in August, that of vegetables was up by an even larger 2.5 percent when compared to July.

Meanwhile, the index for pulses was 1.7 percent higher.

Overall, food inflation also returned to the 7 percent-plus zone, coming in at 7.62 percent in August, up from 6.69 percent in July.

The other volatile item of the CPI basket, fuel, saw a sequential decline in prices, with the index falling 0.4 percent month-on-month.

The indices for the non-food-non-fuel group of items of the CPI all posted sequential increases, with the housing and clothing and footwear indices both rising 0.7 percent. This helped push up core inflation marginally to 5.9 percent in August from 5.8 percent in July, as per Moneycontrol calculations.

On the whole, the general index of the CPI was up 0.5 percent in August compared to July.

Failure report

While the August CPI inflation print is not a surprise - nearly half of the 19 economists polled by Moneycontrol had expected the number to come in at 7 percent or more - it does put the RBI ever so close to failing its mandate.

In such an event - likely to be confirmed once CPI data for September is released on October 12 - the RBI must submit a report to the central government detailing the reasons for failure, remedial actions it proposes to take, and the time period within which inflation will return to target.

The last of these will be a key determinant of future monetary policy action.

In an interview to Moneycontrol late last month, Jayanth Varma, one of the three external members on the Monetary Policy Committee (MPC), had said inflation must be brought down to 4 percent "as quickly as possible".

"The critical question is how quickly inflation can come down to 4 percent because that will impose costs on the economy. Whether it's six months, 12 months, or 18 months, that's a conversation we need to have. And we are getting to the point where we need to have that conversation," Varma had said.

The MPC has raised the repo rate by 140 basis points to 5.4 percent over the last four months. Economists widely expect the repo rate at 6 percent or so by the end of 2022, indicating two more rate hikes in what remains of the calendar year.