India: inflation outlook

CPI inflation came in at 6.1 per cent in February  2022. This breached the upper limit of the tolerance band for inflation set for RBI. 

Some analysts are pressing the panic button and asking for a rise in the policy rate or forecasting one. The raging conflict in Ukraine has lent an edge to concerns about inflation worldwide and analysts in India are no exception.

The analysts need to calm down. Oil prices have fallen back to $100 a barrel after rising much higher. Please note that Russia has not restricted its supply of oil. European nations are continuing to buy oil from Russia as payments related to oil and gas are exempt from sanctions. The earlier rise in oil prices reflected fears about a supply crunch, it's not a supply crunch had happened. True, many commodity prices have risen but this is merely the continuation of a trend that began long before Ukraine.

The war in Ukraine will dampen growth. The IMF had projected growth of 4.4 per cent for the world economy in 2022 compared to growth of 5.9 per cent in 2021. A downgrade is expected with Europe being significantly impacted. India's own growth prospects will not remain unscathed. As growth slows down, inflationary tendencies should recede. In other words, the supply-shock induced inflation should be a transient phenomenon.

The RBI believes that the high levels of inflation in recent months are account of the low base of the previous year. As soon as the base effect peters out, the inflation rate should fall.  This is the basis for the RBI's forecast for inflation for FY 22-23 of 4.5 per cent. Even if we factor in the rise in prices as a result of geopolitical factors, there is no reason to suppose at the moment that the upper band of 6 per cent will be breached. CRISIL has raised its own forecast to 5.4 per cent after taking into account recent developments.

RBI Deputy Governor Michael Patra gives a clearer idea of the RBI's thinking in a recent talk. He makes the following points:

i.  headline inflation has stayed in single digits and has tended to revert back to the target as each supply side shock receded.

ii. India has also transformed its food economy from deficits in key food items to surpluses and exports.

· iiiii. the absence of second round effects on wages and rentals, and low pricing power among corporates and excise duty cuts on petroleum products have tempered these upside pressures.

iv.iv. the evolution of CPI inflation up to January 2022 shows that statistical base effects have been keeping it elevated; the momentum or month over month changes in prices have actually declined during December 2021 and January 2022.

dd  The bottomline? Expect the RBI to revise its inflation forecast upwards at the next MPC meeting but it does not follow that the RBI will move towards raising the policy rate or even signalling one in the future. Growth rather than inflation remains the overriding concern for India.