ExplainSpeaking: Why RBI will be forced to revise its inflation forecast next month


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Dear Readers,

In November last year, this column explained, “Why high prices are here to stay”. As it turns out, retail inflation has continued to rise every passing month since then (see CHART 1 below). According to the latest data, retail inflation (which is calculated using the Consumer Price Index) in February rose to an eight-month high level of 6.1%.

There are three reasons why this trend is noteworthy. Firstly, at 6.1%, retail inflation in February breached the upper-bound of RBI’s comfort zone (6%).

Moreover, this rise, as well as whatever the March inflation data may be, is despite the Indian economy being shielded from the sharp increase in crude oil prices across the world in the wake of the Ukraine crisis.

Even more crucially, however, RBI continued to have a rather sanguine outlook on inflation even in its last monetary policy review meeting, which also took place in February. In its policy statement, the RBI’s Monetary Policy Committee (MPC) stated that “CPI inflation for 2022-23 is projected at 4.5 per cent.” In fact, even though the Russian invasion of Ukraine was on the horizon, RBI continued to expect that inflation is “likely to moderate” in the first half of 2022-23 (or H1:2022-23) and “move closer to the target rate thereafter, providing room to remain accommodative”. Oddly enough, it also patted its back for inflation control when the fact is, as CHART 1 bears out, that retail inflation has been elevated since November of 2019. “Timely and apposite supply-side measures from the Government have substantially helped contain inflationary pressures,” it noted.

Chart 1

In the first week of April, the RBI’s MPC will reconvene for its next bi-monthly assessment of the economy. Here are the main reasons why one can expect the RBI to revise its inflation forecast upwards (and significantly so) in April.

1. Higher crude oil prices: As mentioned above, retail inflation has gone out of RBI’s comfort zone even before higher fuel prices take effect in India. Analysts at Nomura expect “petrol prices need to rise by as much as around 24% cumulatively over the next few months (by Rs 25/litre) and LPG prices by around 33% (by Rs 300/cylinder) to bring them on par with market prices”.

2. Higher natural gas prices: Similarly, natural gas prices, which are closely linked with crude oil prices, are set to spike. For instance, Nomura expects that domestic “gas prices will double to $6-6.5/mmbtu from April 2022 (from $2.9/mmbtu)”.

3. Higher food prices: While higher fuel prices — be it petrol or natural gas — will have a huge bearing on overall inflation directly, these prices would also lead to costlier food items. For instance, higher prices of natural gas, which makes up 80% of the total fertiliser production costs in India, will imply costlier fertilisers, which, in turn, will feed into higher food inflation.

Similarly, higher edible oil prices will raise overall food prices.

Between the two, fuel and food prices account for almost 53% of weightage in the CPI inflation.

4. Higher commodity prices: Look at Table 1 alongside. It underscores the fact that Russia isn’t just a big supplier in the global oil and gas market but also in many other commodities.

Table 1

5. Costlier consumer goods: According to Nomura, thanks to costlier commodity prices, “consumer goods companies are set to further pass on higher input costs to consumers which is likely to affect the retail prices of home appliances, vehicles, personal care products and non-durables (FMCG products)”.

6. Costlier services: The services sector has possibly been the worst affected during the Covid pandemic. As far as different sectors of the economy go, the services sector was the biggest laggard in recovering to the pre-Covid level. As Covid caseload comes down, the services sector is expected to resume activity and this is likely to lead to higher prices of such services e.g education.

It is for these reasons that most observers have been revising (down) their growth projections while raising the inflation forecasts.

But it is not all gloom and doom. Two crucial bits must be remembered.

One, India is not alone in facing these trends. Take a look at Table 2, sourced from Moody’s Investor Service. Firstly, it is clear that, for India, the inflation projection for 2022 and 2023 is much higher than the RBI’s forecast but also even these estimates have worsened since late February.

Table 2

But India is by no means the worst affected. Look at some of the economies that India is typically categorised with such as South Africa or Brazil. The picture gets even worse for other developing economies such as Turkey and Argentina. Even in the developed world countries such as the UK and the USA, which are not used to such high inflation rates, the picture is comparatively worse than in India.

Two, according to an analysis by CRISIL (see CHART 2), even if fuel prices were to climb back to the levels last seen in 2012 and 2013, India’s domestic inflation may not reach the same levels as in the past.

Chart 2

Why? Look at the colour of the bars. According to analysts at CRISIL, of the three components of overall inflation — food, fuel and core — at present, both food and core inflation levels are still considerably lower than a decade ago.

Lastly, a big domestic factor that may have a huge bearing on how domestic inflation pans out is the monsoon. If India were to receive another year of normal Monsoon rainfall, it will keep food inflation in check. The only fly in this ointment is the fact that if India gets a normal monsoon this year, it will be the fourth straight year of normal monsoon rainfall, and that is quite a rare occurrence. One has to be ready to contemplate the scenario: What if the monsoon fails us this year?

Anyway, one thing is largely certain, the consensus view among most analysts tracking India is that inflation is going to be much higher than the 4.5% (for 2022-23) forecast by the RBI in February. As such, most expect that India’s central bank will be forced to change its inflation outlook when it reconvenes on April 6.

Should RBI recalibrate its inflation outlook? Share your views and queries at udit.misra@expressindia.com

Lastly, don’t forget to catch the latest episode of The Express Economist where Dipti Deshpande, principal economist of CRISIL, answers all your queries about the rise and fall of the Rupee’s exchange rate.

Stay safe,
Udit





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