Businesses' one-year CPI inflation forecast jumped to 5% in August: IIM survey

Inflation expectations are keenly eyed by policymakers as anchoring them is critical to ensuring price stability.

Businesses' forecast of one-year-ahead headline retail inflation rose sharply to 5 percent in August from 4.56 percent in June, according to the latest Business Inflation Expectations Survey (BIES) of the Indian Institute of Management-Ahmedabad (IIM-A).

The survey, which measures inflation expectations of firms, also asks businesses to predict Consumer Price Index (CPI) inflation one year down the line in alternate months to coincide with the meetings of the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC).

The MPC, which began its three-day meeting on October 4 morning, will announce its interest rate decision at 10 am on October 6, where it is largely expected to maintain the policy repo rate at 6.5 percent for the fourth time in a row.

Economists, however, expect the central bank to raise its inflation forecast for 2023-24 by 20-30 basis points after CPI inflation hit a 15-month high of 7.44 percent in July before cooling to 6.83 percent in August.

One basis point is a hundredth of a percentage point.

Data for September, to be released on October 12, is expected to fall further but could stay above the upper bound of the central bank's 2-6 percent tolerance band for the third consecutive month.

According to ratings agency CareEdge, inflation will exceed the RBI's July-September inflation projection by around 60 basis points and the central bank "will consequently revise its whole-year projection to 5.6 percent from an earlier projection of 5.4 percent".

If the RBI makes an upward revision, similar to the increase in firms' one-year-ahead CPI inflation forecast – which hit 5 percent for the first time since October 2022 – it could hit current market expectations of a rate cut sometime in the first quarter of 2024-25.

In an interview to Moneycontrol in late June, MPC external member Ashima Goyal said a sequence of forecasts showing inflation of under 5 percent would present an opportunity to reduce the repo rate.

The RBI's most recent forecast, from August, pegs CPI inflation at 6.2 percent in July-September, 5.7 percent in October-December and 5.2 percent in each of the first two quarters of 2024.

Stable expectations

While businesses see one-year-ahead retail inflation significantly higher now than they did in June, their inflation expectations – based on the costs they face – were unchanged from July at 4.31 percent.

"The recent spurt in CPI inflation has limited impact on firms' inflation expectations," Abhiman Das, professor of economics at IIM-A, who conducts the survey, said. "In fact, the average inflation expectation of the firms remained anchored around 4 percent for the past four consecutive months."

The latest results of the BIES, which largely polls manufacturing firms, are based on the responses of around 1,000 companies. Most of the responses were received in the second half of September.

Inflation expectations are keenly eyed by policymakers, as anchoring them is critical to ensuring price stability. On August 10, the MPC said it remained "resolute in its commitment to aligning inflation to the target and anchoring inflation expectations".

IIM-Ahmedabad's inflation expectations survey is one of the only two surveys conducted in India to measure inflation expectations. The other is the RBI's Inflation Expectations Survey of Households. The latest round of the survey, released on August 10, showed that both three-month-ahead and one-year-ahead inflation expectations of households decreased by 10 basis points each to 10 percent and 10.3 percent in July.

Moderation in cost pressures has not only helped stabilise inflation expectations but also boosted sales and profit margins expectations.

According to the latest IIM survey, about 52 percent of firms reported "much less than normal" or "somewhat less than normal" sales in August, well below 61 percent in July, while 39 percent of firms now see profit margins to be "about normal" or greater, up from 32 percent before.

The survey measures "normal" as the average of the preceding three years, excluding the Covid-19 period.