Reserve Bank of India (RBI) staff think a "low inflation regime" is not far away for the Indian economy.
"...there is a rising probability since the second half of 2022-23 that the Indian economy is transiting away from the high regime," a paper by RBI staff, released on April 21 as part of the central bank's monthly bulletin, said.
The paper, authored by Deputy Governor Michael Patra, Joice John, and Asish Thomas George - all from the central bank - do not represent the views of the RBI.
"For monetary policy, the recommendation would be: wait and watch, while guiding inflation towards the imminent onset of a low inflation regime," the paper added.
The paper comes just over a week after data from the statistics ministry showed headline retail inflation dropped to a 15-month low of 5.66 percent in March thanks to a favourable base effect. The favourable base effect will be in play again in the data for April, set to be released on May 12, with economists predicting Consumer Price Index (CPI) inflation will likely fall below 5 percent this month.
CPI inflation averaged 6.7 percent in 2022-23. The RBI expects it to decline to 5.2 percent in 2023-24.
Shift in inflation regime
According to the paper by Patra, John, and George, following the informal adoption of the flexible inflation targeting regime in 2014, inflation moved from a 'high regime' where it averaged more than 8 percent to one where averaged 4.4 percent.
However, inflation has then see-sawed between high and low regimes, first moving to the former following the coronavirus outbreak in early 2020, reverting to a low regime in early 2021 as the pandemic eased, before Russia's invasion of Ukraine in February 2022 shifted it back to a high regime. But starting the second half of 2022-23, the authors' analysis suggests inflation started moving back to a low regime.
"After the Covid-19 shock in early 2020, inflation persistence started to increase till it peaked in April 2022. More recently, intrinsic inflation
persistence seems to be on a declining trajectory," the paper added.
Headline to core
The authors' analysis also showed that headline inflation converges to the core inflation rate.
"Further, the transitory shocks emanating from the non-core part are expected not to affect core inflation beyond a period of 12 months," the paper added.
This finding backs the Monetary Policy Committee's (MPC) focus on core inflation in recent months. Core inflation, inflation excluding food and fuel, has been sticky around the 6 percent mark for the better part of two years. As such, it can form a floor for headline retail inflation and keep it from easing to the RBI's medium-term target of 4 percent.
"Additional evidence that inflationary pressures in India are easing is found in the decline in the month-on-month momentum of core inflation, reinforcing empirical support for a low inflation regime ahead of us from the proposition that headline inflation will inevitably converge to its core," the paper said.
However, among all the good news, there was also a word of warning on account of demand-pull pressures getting stronger.
"For monetary policy, therefore, there can be not letting down of the
guard. Readiness to act pre-emptively to ensure that the disinflation that is underway is not interrupted is our policy recommendation for the way forward."
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