RBI’s assessment of inflation falling to 4% over next 2 years seems accurate, say economists

The Reserve Bank of India’s (RBI) assessment of retail inflation falling to 4 percent over the next two years seems accurate given that price pressures in the economy have peaked, economists told Moneycontrol on Thursday, August 25.

“Inflation could come down to 4 percent by 2024 as the slowdown in global growth and easing of supply disruptions brings down input costs,” said Sakshi Gupta, senior economist at HDFC Bank. “Moreover, this assumes that the monsoons are normal for the next two years. The pent-up demand effect in India is also likely to fade and supplies will catch up, stabilising core inflation as well.”

RBI governor Shaktikanta Das, who is also the head of the six-member monetary policy committee (MPC), in an interview with ET Now channel on August 22 said that it has set a two-year timeframe to bring down inflation closer to its 4 percent target. Inflation and inflation expectations are increasingly getting anchored, he added, stating that inflation has peaked and is expected to moderate.

Gupta agreed with the RBI’s assessment that inflation in India has peaked. In fact, there could be some downside risks to the forecasts if the momentum of food inflation slows down and if oil prices correct downwards as recession fears rise globally, she said.

Where is inflation headed?

Data released on August 12 showed India’s headline retail inflation rate, as measured by the Consumer Price Index (CPI), fell to a five-month low of 6.71 percent in July. Inflation had jumped to an eight-year high of 7.8 percent in April following Russia’s invasion of Ukraine. Inflation has ruled above the RBI’s medium-term target of 4 percent for 34 consecutive months and seven straight months outside the central bank’s 2-6 percent tolerance range.

As such, the central bank is only two months away from failing to meet its inflation mandate, which is deemed to occur when the average inflation is outside the 2-6 percent tolerance range for three straight quarters. If the MPC fails to meet its inflation mandate, it will have to soon draft its response to the government. The letter will give reasons on what led to the failure in meeting the target and spell out ways to bring inflation back within the target level.

Also read: Banking Central | What MPC’s inflation failure means to common man

As per the RBI’s latest forecast released on August 5, CPI inflation is seen averaging 7.1 percent in July-September. After that inflation is seen easing sharply to 6.4 percent in October-December and 5.8 percent in the first quarter of 2023. In the second quarter of the next calendar year, CPI inflation is seen falling further to 5 percent.

Economists said that a major factor contributing to lower inflation levels would be the monetary tightening across central banks that has led to a softness in global growth momentum. This should keep commodity prices in check. Hence, assuming crude oil prices hold around $100 per barrel, domestic retail fuel prices will likely remain unchanged. This, coupled with better sowing and improved agricultural income, could further aid the downward drift in inflation, they said.

“Base effects may well cause a minor uptick in the CPI inflation in August-September relative to the July print, after which we expect a considerable cooling in October-March,” said Aditi Nayar, chief economist at ICRA. “We anticipate that the actual inflation outturn will mildly trail the MPC’s forecasts for Q2 and Q3 FY23.”

Uncertainties persist 

Even if inflation may have peaked for now, economists said global and domestic uncertainties and sticky core inflation could persist.

“An upside risk remains from lower sowing (acreage) of rice, revised GST (goods and services tax) rates on unbranded items and rural consumption demand picking up, going forward,” said Dipanwita Mazumdar, economist at Bank of Baroda. “There will be an unfavourable base from September-November, which might keep the inflation print elevated. There can be a double whammy in terms of a growth slowdown in China, which might further aggravate supply chain bottlenecks.”

Kunal Kundu, India economist at Societe Generale, concurred with Mazumdar’s view. A patchy monsoon and recent imposition of 5 percent GST on hitherto untaxed items could potentially keep prices elevated, he said.

Rate hikes to continue 

Economists also expect the MPC to continue hiking interest rates to contain price pressures. The MPC has already hiked the repo rate by 140 basis points (bps) since May to keep a lid on soaring prices. One basis point is one-hundredth of a percentage point. However, the pace of rate hikes could slow, they said.

“Our inflation trajectory indicates that headline CPI inflation will edge below the 6 percent mark sustainably in Q4FY23 (January-March), supporting the continued frontloading of rate hikes,” said Gaura Sen Gupta, India economist at IDFC First Bank. “Looking ahead, we expect the pace of rate hikes to moderate with a 35 bps hike expected in September followed by a 25 bps hike in December. This will take the terminal repo rate to 6 percent.”

Also read: MC Exclusive | India’s rate-setters on growth, inflation and forward guidance

According to Karan Mehrishi, an independent economist, the RBI’s problem is not just about controlling domestic inflation but also keeping rates competitive amid a rapid reversal of quantitative easing globally.

“Having said that, the inflation picture is still nebulous and it is too early to assume how it pans out from here,” said Mehrishi. “Nonetheless, the RBI might not take chances and continue with some frontloading of rate hikes.”