Lowering inflation expectations closer to 4% key policy goal: MPC’s Shashanka Bhide

Indians' three-months-ahead inflation expectations declined by 50 basis points in July to 10.3 percent, while one-year-ahead expectations fell by 60 basis points to 10.5 percent, according to the RBI's latest household survey.

The Indian Institute of Management-Ahmedabad's Business Inflation Expectations Survey showed one-year-ahead expectations of producers fell by 41 basis points in June to 5.17 percent.

Policymakers keenly eye the directional movement of inflation expectations and not the level itself because it is crucial to ensuring price stability.

Actual inflation

While inflation remains high, Bhide said July's CPI inflation data – released after the MPC's 50-basis-point repo rate hike on August 5 – suggested overall price levels seemed to have stabilised, with the general index of the CPI up only 0.5 percent from June.

"The impact of the government's measures in terms of taxes and tariffs have a significant impact in the short term," Bhide said. "The other steps take longer to show the impact. The steps in the case of edible oils, for example, were effective. The broader measures relating to energy and fuels have an impact on sectors including food commodities."

However, fresh pressures keep appearing. Last week, Gujarat Co-operative Milk Marketing Federation Ltd. and Mother Dairy increased milk prices by Rs 2 per litre, citing rising input costs. According to economists, the milk price hike could raise the August inflation number by about 20 basis points, with milk and related products making up 6.61 percent of the CPI basket.

For Bhide, more than one-time price increases, the subsequent spill overs make inflation broad-based.

Given the price pressures, it is no surprise the RBI's forecast of 7.1 percent for July-September is looking par for the course. A third consecutive quarter of CPI inflation staying outside the 2-6 percent tolerance range would result in the RBI failing its mandate.

Asked whether the MPC had discussed the possibility of failure, Bhide said projections for July-September "clearly imply the likelihood of failure to meet the mandate."

The RBI must submit a report to the central government spelling out the reasons for failure, the remedial actions it proposes to take, and an estimate of when inflation will return to target.

Bhide said he wasn't sure what procedure would be followed in writing the report, but he expected the external members of the MPC to provide inputs.

Growth challenge

According to Bhide, the Indian economy appears to have sustained the projected growth momentum in April-June, data for which will be released at the end of August. The RBI expects India's GDP to grow 16.2 percent in the first quarter of FY23 due to a favourable base effect.

"While external environment is a concern, improving capacity utilisation in manufacturing and resolution of some of the supply bottlenecks are positives for sustaining growth momentum. About 7.2 percent growth in FY23 is a realistic projection," Bhide said.

However, weakening demand from overseas would adversely impact India's export performance and improvement in domestic demand may not make up for the absence of this export push.

Even when it comes to growth, the answer lies in lowering inflation expectations.

Asked about fellow-external member Jayanth Varma terming the MPC's decision to remain focused on withdrawal of accommodation as confusing, Bhide said that, to him, the stance essentially implied the committee was still focused on the need to cool down inflation pressures as inflation is "well above" the 6 percent upper bound of the tolerance band.

"Anchoring inflation expectations close to the target is necessary to achieve this target and also the goal of economic growth," Bhide said.