Thursday 26 May 2022
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RBI may revise inflation forecast upward

It may work out above the upper limit of the 2-6% mandate of the RBI for a third consecutive month in March, data for which will be released on 12 April

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The Reserve Bank of India (RBI) is still working on its inflation forecast and the numbers are “still on the drawing board”, Governor Shaktikanta Das said, speaking at an industry event on 21 March when quizzed on how domestic inflation would evolve in the coming months.

Economists at the may be working it out right up to the last minute, sources said. A day after the governor’s statement, oil marketing companies raised petrol and diesel prices by over 80 paise/litre. A hike in the price of domestic liquefied petroleum gas cylinders by more than Rs 50 quickly followed. The previous week, bulk diesel prices were increased such that they exceeded retail prices by Rs 25 a litre. The result cannot be any good when it comes to inflation.

The scenario was dicey even before fuel prices were hiked after 137 days. Data released on 14 March showed Consumer Price Index (CPI) inflation rose to 6.07% in February from 6.01% the previous month.

The rise in inflation was not much, but it was unexpected. Economists foresee it as working out above the upper limit of the 2-6% mandate of the for a third consecutive month in March, data for which will be released on 12 April. This means inflation may exceed the RBI’s forecast of 5.7% for January-March unless it falls to at least 5.1% this month.

The MPC must have failed when average CPI inflation is outside the 2-6% band for three consecutive quarters. With all indications being that inflation will average more than 6% in the first quarter of 2022, it leaves us with April-June and July-September.

The current forecast by the says headline retail inflation will average 4.9% and 5.0% in the next two quarters and 4.5% in FY23. These numbers, however, are seriously outdated.

Recently, Nomura revised its already-high inflation forecast for 2022 of 5.9% to 6.3%. According to Nomura, domestic petrol prices must be increased by as much as 24%, or Rs 25 per litre, over the next few months to bring them on the same level as market prices. This week’s price hike accounts for only a small fraction of that estimated increase.

While Nomura has been one of the more hawkish commentators, with their economists predicting the MPC will be forced to increase the repo rate at its June meeting, and pencilling in a total of 100 basis points of rate hikes for 2022, others expect a big increase in the inflation forecast next month too.

Sirf News Analysis: RBI inflation forecast

For example, QuantEco Research now sees CPI inflation averaging 6.1-6.3% in FY23, or 80-100 basis points (bps) higher than its previous forecast. “It is possible the inflation forecast has also increased by a similar margin since we were pegged at around 5.3% and have raised it by 80-100 bps,” says Yuvika Singhal, the economist at QuantEco Research. “I do not see any reason why the RBI would not raise its forecast to the same extent. So their forecast of 4.5% for FY23 will probably be closer to 5.5%.”

A lot depends on the price of India’s crude oil basket assumed by the to forecast inflation. The October edition of the Monetary Policy Report revealed the central bank assumed a price of $ 75 per barrel for the second half of FY22. However, the average price of India’s crude oil basket was $ 83 a barrel in October 2021-February 2022. The prices in March will only raise this figure for the latter half of the year.

While QuantEco has assumed a crude oil basket price of $ 100 a barrel for FY23, Morgan Stanley has pegged it at $ 110 per barrel, resulting in a CPI inflation forecast of 6% for the next financial year.

“We think CPI will remain above the 6% mark until September, and only decelerate to 5.6% by Q4 2022,” Morgan Stanley had said in a note on 14 March.

If the CPI inflation remains above 6% until September, the MPC would fail to meet its mandate for the first time, having only avoided doing so in 2020 on the technicality that inflation based on imputed data constituted a break in the CPI series.

In his interaction on 21 March, the governor said there was only a “very, very remote possibility” that inflation would keep exceeding 6%.

Why is optimistic

The Covid-19 pandemic has seen a shift in the manner in which the MPC has targeted inflation, moving from the medium-term target of 4% to keeping it in the 2-6% band. In that case, failure seems to be the only reason that may force the committee to act.

A sharp upward revision in the inflation forecast will influence expectations. And the has seemingly been keen to manage expectations through its inflation forecasts. The projections announced on 10 February had surprised most economists, with Rajni Thakur, RBL Bank’s chief economist, noting on the day it was likely “RBI is trying to buy time and focus on managing rates expectations” for the remainder of FY22.

Can the same be done on 8 April? A way to do so would be to assume a lower crude oil basket price using the argument that the current high levels were unlikely to sustain for long. With the Monetary Policy Report set to be released next month, there will be no hiding the crude oil price underpinning the forecast.

The inflation forecasts may also not get a sharp upward push if the thinks the government may cut the fuel excise duty or if the pass-through to pump prices is unlikely to be large. A third way out could be to pin hopes on food inflation softening the blow from higher fuel prices and their second-round effects.

“But for clarity on food inflation dynamics only emerges around the end of July and the start of August,” pointed out Singhal of QuantEco Research.

Transparency and predictability are the cornerstones of the flexible inflation targeting framework. But for it to remain so, the RBI inflation forecasts must be honest.

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