Interview | Inflation expectations got unanchored several months ago, says IIM’s Abhiman Das

Despite not being part of popular debates, inflation expectations are keenly eyed by policymakers as they are inextricably linked to India's flexible inflation targeting framework. In 2014, the Urjit Patel-led expert committee to revise and strengthen the monetary policy framework had said that anchoring inflation expectations was critical to ensuring price stability.

"The discourse on inflation right now is that if we have less than 6 percent inflation, inflation expectations are anchored. No! Both volatility and trend matter. If you find inflation is volatile and trend upwards, that means inflation expectations are not anchored and one has to be very careful," Abhiman Das said.

Data released on May 12 showed Consumer Price Index (CPI) inflation surged to 7.79 percent in April, the highest it has been since May 2014. Crucially, it was the 31st month in a row that CPI inflation had come in above the RBI's medium-term target of 4 percent.

The latest retail inflation print has also pushed the MPC closer to failure, which is deemed to have occurred when average CPI inflation is outside the 2-6 percent tolerance band for three consecutive quarters. Inflation, having averaged 6.3 percent in January-March, is widely expected to be above 6 percent for the whole of 2022.

Meanwhile, Wholesale Price Index (WPI) inflation hit a 30-year high of 15.08 percent last month.

Das and BIES

Before joining IIM-Ahmedabad in 2015, Abhiman Das spent over 20 years in the RBI's statistics department, working closely on its inflation forecasts and the household inflation expectations survey.

At IIM-Ahmedabad, Das started the Business Inflation Expectations Survey (BIES), which, he said, has been showing worrying trends starting from October 2020.

"Through BIES, I have been saying, starting from October 2020, that inflation is rising. Input costs of firms are rising. BIES was the first to indicate that during a time of significant demand slowdown due to COVID-19, you may see high inflation," Das said.

"The BIES has been showing that inflation expectations are rising persistently and I have been writing for the last 4-5 months that inflation looks to be unanchored," he said.

Great expectations

For him, the importance of inflation expectations cannot be understated, whether they be of households or businesses, though those of businesses are more closely aligned with realised inflation.

Inflation expectations a year ahead for households, as per the RBI's survey, have been in double-digit territory since May 2020. This is after spending nearly five years below 10 percent, barring a few months.

The RBI says monetary policy decisions focus more on the direction of changes of households' inflation expectations rather than the number itself.

Meanwhile, inflation expectations one year ahead for businesses as per the BIES, were as low as 3.62 percent in January 2020. However, they jumped to 4.28 percent in November 2020 from 3.78 percent in October 2020. Since then, they have steadily risen. In January, before Russia invaded Ukraine, they rose sharply to 5.94 percent from 5.45 percent in December.

The latest two prints for February and March have both been above 6 percent.

The elevated inflation expectations of households have often led to criticism of the RBI survey. But Das, who has been working on inflation expectations for the last decade, pointed out that these expectations were valuable and only a consequence of past inflation levels.

"The persistence of inflation close to 5-6 percent or more is common in India. So you can't expect Indian households to give a low inflation expectations number."

"In the US, for example, people have been able to buy a bottle of Coca-Cola for a dollar in the last 20 years. We don't see that in India. So if we really want to lower inflation expectations, it is important to keep actual inflation low for a much longer period. This is a point most analysts miss," Das said.

No independent analysis

The RBI's inflation forecasts have been questioned vigorously over the past few months—never more so than in February when it said CPI inflation would average 4.5 percent in FY23.

At the time most economists saw average inflation in FY23 at 5 percent or so. But according to Das, the RBI has been "underestimating inflation to a large extent", a more damning assessment considering his experience in running the central bank's inflation forecasts.

Das is also concerned about the lack of independent examination of the RBI's analysis by the external members of the MPC.

"The MPC has six people who set the repo rate. But if they are fed with the same set of analysis, they will arrive at the same answer!"

"The external members right now come and sit at the RBI for two-three days. Whatever the RBI staff come and tell them becomes the projection. But who says that projection is right? Even if you look at the minutes of MPC meetings, everyone is talking about RBI surveys. There is no independent way to validate anything. Have you ever seen the final decision being different from what the governor has said? It has not happened."

According to Das, external members of the MPC cannot generate their own numbers and analysis while they are part-time members without an independent research setup.

Chetan Ghate, an external member of the MPC from October 2016 to September 2020, had told this reporter in August 2021 that the monetary policy framework would benefit from external members being full-time appointments.

Das' focus, though, is on inflation expectations.

"Inflation expectations have not been given enough attention. And we can now see what is happening," he says.