Will RBI increase common man inflation worry?

Unanimity eludes the analyst community in regard to the inflation trend likely to be stated by the Reserve Bank of India (RBI) in its mid-year monetary policy review tomorrow. An upward revision in inflation forecast would likely have a bearing on the forthcoming elections in the politically sensitive state of Gujarat.

While a section of analysts argued that RBI might upwardly revise its inflation forecasts for March 2013 as September inflation moved higher and came in at 7.81%, way above consensus estimates, others averred that the central bank would maintain status quo.

The jump up in inflation in September (from 7.55% in August) was largely a result of the hike in diesel prices. While RBI has forecasted the headline inflation rate for March 2013 to be 7%, there is not a single month so far in the current fiscal (2012-13) where inflation was lower than this forecasted print rather it has been sticky in the 7.5 -7.8% range.

Commenting on the hypothesis, Sajjid Chinoy, Economist-Asia, JPMorgan, opined, “I think RBI might revise the inflation forecast for this fiscal. It’s most likely that RBI won’t meet the forecasted seven per cent rate for March 2013 owing to diesel price hike and sub- par monsoon. In case, if they do ease the monetary policy then it would be hard to revise the inflation forecasts upwards on one hand and cut the rate on the other hand simultaneously. However, if they don’t cut policy rate then explicitly they would increase the inflation forecasts for March.”

Chinoy’s thought got an endorsement from DK Joshi, director and principal consultant, CRISIL, who averred, “There is likelihood that RBI may revise the inflation forecasts.”

However, Samiran Chakrabarty, head of India research at Standard Chartered Bank has a different view point and argued, “They (RBI) are already at 7% and they might not find enough reasons right now to change the inflation forecasts. However, they may revise the growth number numbers downwards.”

In sync with Chakrabarty, DR Dogra, managing director and CEO, CARE Ratings, said, “I do not think that the RBI will change the inflation forecast as of now for the year from 7%. This is because we can expect inflation, which is above 7.5% as of today to move downwards gradually due to two factors: the arrival of the kharif harvest from October onwards which will bring down food price inflation and high base year effect. Given the worldwide economic conditions, we have also seen that the global commodity prices have begun to soften or stabilizing. Therefore, there is reason to believe that inflation would come down, though not significantly below the 7% mark by yearend.”

It is quite interesting to know that in recent years, forecast errors on inflation made by RBI have been large. For instance, during 2011-12, inflation print was 7.7% in March 2012 as against the last estimate of 7% made by RBI. (http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=26665)

Explaining the rationale behind these large forecast errors on inflation, Chakrabarty at Standard Chartered Bank, said, “Global commodities prices have been very volatile and exchange rate has moved wildly. Furthermore, inflation has proven to be stickier than one would have anticipated. So even, with the decline in growth, prices have not come down as much as when compared to earlier cycles.”

Another school of thought came from Joshi at CRISIL, who affirmed, “Economic environment has remained fragile and uncertain. In such a scenario, any error found in forecasting is beyond the control of RBI.”
Commenting on the measures needed to tame inflation which has been the biggest macro challenge in recent years, Chakrabarty at Standard

Chartered Bank, asserted, “As RBI has repeatedly mentioned that whatever interest rate tightening was required they have done that in the past. Now, supply side reforms are required to tackle inflation. For instance, in case of FDI in multi-brand retail where 50% of FDI is mandated to go towards the back-end infrastructure should help in easing the bottlenecks related to food supply chain. Similarly, GST could have significant impact on the better mobility of goods and services. These sorts of supply side reforms can help to bring down the inflation.”

Reiterating the view, Chinoy at JP Morgan, said, “The best way in which inflation can be controlled would be where government can remove some supply constraints in order to provide a boost to investment. While demand has been strong, investment has remained weak in the past.

Infrastructure supply would enhance if you have National Investment Board (NIB) and a better land acquisition policy in place.”