As the monetary policy committee (MPC) of the Reserve Bank of India braces for its next meet on Wednesday, it might review its forecast of inflation, the most important input for monetary policy-making, again. In recent years, the central bank’s inflation projections seem to have overstated the actual price pressure in the economy, leading to economists in the government, at times, questioning the basis of its monetary policies.
An analysis of inflation data in recent years suggests that only in three of the past 24 months through October 2018 food inflation exceeded the 4% mark, having averaged just 1.7%. Food inflation had fallen from a peak of 3.1% in May 2018 to deflation (-0.9%) in October. This, in turn, has kept a leash on the headline retail inflation, even though core inflation has breached the 5%-mark during this period.
As for the RBI’s forecasts, the monetary policy statement in April projected CPI inflation for the first half of 2018-19 at 4.7-5.1% and 4.4% for the second half. In June, it revised it to 4.8-4.9% for H1 and 4.7% for H2. In August, it projected 4.6% inflation for the September quarter and 4.8% for the second half of this fiscal, but the actual average CPI inflation in H1 stood at 4.3%. In October (before inflation data for October were available), it again revisited the inflation forecast and predicted inflation in the 3.9-4.5% range for H2FY19. Retail inflation in October touched 3.3%, having eased for a third straight month.
In the second part of the Economic Survey for 2016-17, released in August 2017, then chief economic advisor Arvind Subramanian pointed out that the RBI had overestimated inflation by more than 100 basis points in six of the past 14 quarters, with the average error being as much as 180 basis points. The benchmark interest rate of 6% in August 2017 was above the neutral nominal rate by 25-75 basis points, the survey had said.
While frequent revisions in forecasts may be necessitated by various complex churns in the economy, monetary policies – based on an overstated inflation trajectory – tend to move towards inflation control at the cost of growth, government officials have often argued.
On the other hand, deflation in food articles in October due to steady supplies has complicated the task of inflation forecasting, some analysts reckon (The government’s recent move to raise MSPs to ensure a 50% profit to farmers over their A2+FL costs hasn’t made any big difference to prices so far, as procurement at these prices has been very limited).
Commenting on inflation, Sonal Varma, chief India economist at Nomura, said: “Cost pressures are already on a decline due to sharply lower oil prices and stable currency and recent developments among shadow banks and the impending fiscal belt tightening are yet to fully reflect in growth numbers.”
Analysts FE spoke to have predicted a pause on policy rates, including at all the remaining policy reviews in FY19 (in December and February), thanks to recent correction in global crude oil prices, relatively soft food prices and strengthening of the rupee.
However, with Friday’s GDP data showing a moderation in growth to 7.1% in Q2FY19 from 8.2% in Q1 due to a slowdown in private consumption, some now predict even a rate cut by the MPC this fiscal, if not next week. Shubhada Rao, chief economist at Yes Bank, said: “Global deflation in food, spread of e-NAM coverage across domestic markets, and efficient management of food stocks have helped in reigning in overall price pressures.”
DK Joshi, chief economist at Crisil, said unfavourable base and higher crude oil price compared with last year (despite the latest correction) would drive inflation for the remaining months. Farm supplies have remained in surplus while elevated minimum support prices haven’t yet fed into food inflation, as procurement hasn’t yet been in large volumes to influence market prices, he added.