Is the RBI's new inflation forecast already outdated?

Economists have raised their CPI inflation forecasts for 2023-24 above RBI's 5.4 percent projection.

An adult butterfly is said to have an average life-span of two weeks — more than three times the shelf-life of the Reserve Bank of India's (RBI) inflation forecast. On August 10, the central bank raised its inflation forecast for the current financial year by 30 basis points (bps) to 5.4 percent. Much of this upward revision was driven by the sharp hike in the projection for the second quarter, with the central bank expecting Consumer Price Index (CPI) inflation to average 6.2 percent, 100 bps higher than it previously thought.

But that was last week.

CPI inflation data released four days later, on August 14, has changed the outlook substantially despite a certain degree of preparedness among central bank watchers — and the central bank itself — that the surge in vegetable prices would push inflation for July above the upper-bound of the RBI's 2-6 percent tolerance range. What almost no one anticipated was that inflation would rise as high as 7.44 percent. So does this render obsolete the RBI's newly-revised inflation forecast? Economists certainly seem to think so.

Also Read: What the economist who got July CPI inflation (almost) right thinks will happen next

"With the surprise uptick in July inflation, we expect inflation to track above 7 percent in August, and thereafter revert to around 6.5-7 percent in September/October," Morgan Stanley economists Upasana Chachra and Bani Gambhir said in a note on August 15.

Morgan Stanley expects CPI inflation to average 7.3 percent in July-September and 6 percent in October-December.

"We thus increase our 2023-24 inflation estimate to 5.7 percent from our earlier expectation of 5.4 percent," Chachra and Gambhir added.

Morgan Stanley isn't alone in their pessimism about India's inflation trajectory. A few other economists have also raised their full-year forecasts by 10-50 bps in the aftermath of the eyebrow-raising data. Almost all of these new forecasts are higher than the RBI's 5.4 percent projection. Ratings agency CRISIL, for instance, has upped its number for 2023-24 by 50 bps to 5.5 percent, citing early signs of "minimum relief on food prices" in August.

"This forecast too faces upside risks from high global food prices and a possible setback from evolving El Niño conditions. Persistently high food inflation may also transmit to non-food items," CRISIL added.

Economists think vegetable prices should start easing in August or September. This could help bring inflation below 5 percent before 2023 ends. However, there is no denying the impact of a couple of outliers - such as the 7.44 percent inflation figure for July and another 7 percent-plus print in August - on the trajectory.

Now, when the average inflation figure for the full-year changes, so do monetary policy expectations — something that has already started to happen.

"As we expect inflation to track at 6 percent in October-December, we delay the start of the easing cycle to April-June 2024 from January-March 2024," Morgan Stanley's Chachra and Gambhir said.

Given that monetary policy must be forward looking, an indicator of what the Monetary Policy Committee (MPC) might do is RBI's inflation forecast as opposed to incoming monthly numbers. So, any change to the expected inflation path that RBI announces in early October will be key to shaping policy expectations.

The RBI, however, has previously attracted some criticism for making minor 10-20 bps changes to its forecasts as they create uncertainty. Interestingly, in his statement announcing the MPC's decision to maintain the status quo on rates on August 10, Governor Shaktikanta Das had said the RBI can choose between modifying its inflation projections every two months, if needed, "in the interest of better guidance; or avoid frequent changes and revise them on fewer occasions for simplicity of presentation".

It would not be a complete surprise, then, if the RBI chooses to retain its outdated 2023-24 forecast in October instead of raising it slightly to 5.5 percent or so.