How the inflation story changeth

It was not very long ago that a debate was stirred-up about the inflation forecasts issued by the Reserve Bank of India. The argument then was simple: The RBI inevitably painted a picture of inflation showing up higher than it actually had moved. These projections meant that the RBI was never really ready or willing to push down the policy repo rates in enough good time to enable growth. There was the demand to look at other business surveys that offered other (lower) inflation projections that rivalled the RBI’s reading.  

Some two quarters down the line, as the RBI issued its first monetary policy statement for a new fiscal (2018-19), the picture is this: inflation continues to stand as a red flag. The Monetary Policy Committee resolution released on Thursday (April 05, 2018) offers six uncertainties that give an upside risk to inflation: (i) the higher Minimum Support Price as announced in the Union Budget 2018-19 for kharif crops, (ii) the staggered impact of HRA revisions by various State governments, (iii) continuous fiscal slippage of the Union Budget estimates and at the level of states on account of higher committed revenue expenditure, (iv) monsoons (v) Pointers to rising input and output prices as seen in the RBI’s Industrial Outlook Survey, (vi) volatility in crude prices.

In the light of this, the MPC resolution of April 5, 2018, has held the policy repo rate at 6 per cent against a backdrop of some optimism in growth outlook and serious concerns of an upside risk to inflation. It is important to note that MPC in Dec. 2017 and Feb. 2018 voted to keep the policy repo rate on hold at 6 per cent. Thus, this is the third successive resolution holding the rate primarily due to inflation concerns. The MPC claims that its decision to hold the repo rate is consistent with the monetary policy objective of the RBI of having pricing stability keeping in mind growth.

However, a look at another important document released simultaneously – the Monetary Policy (half yearly) Report (April 2018) points to higher inflation outlook for 2018-19 and 2019-20. Given that this is going into what will be a very interesting election year, the risks to inflation are even higher and therefore comes the need to rein in inflation firmly rather than catching the tiger by the tail, which is in any case suicidal.

The resolution of the monetary Policy Committee lowered the February CPI inflation forecast for H1 from 5.1-5.6 per cent to 4.7-5.1 per cent and H2 from 4.5-4.7 per cent to 4.4 per cent. This is under the assumption of overall food inflation being under check on account of normal monsoon and effective supply management by the government.

The half-yearly Monetary Policy Report (MPR), the RBI document, has stated that CPI inflation will be higher at 5.1 per cent in Q1 of 2018-19 due to unfavourable base effects. However in Q2(4.7 per cent), in Q3 and in Q4 (4.4 per cent), there will be signs of moderation but the risks will be tilted to the upside.

For 2019-20, MPR assumes a normal monsoon and no measure exogenous policy shocks and set out a forecast of CPI inflation in a range of 4.5 to 4.6 per cent. Interestingly, for the Q4 of 2019-20, the upper range of inflation forecast is in the range to 6.1-7 per cent with risks on the upside.

All inflation numbers are thus coming in above 4 per cent, going beyond the upper limit of the RBI’s operating band of 6 per cent when it reaches 2020, as given in the MPR. This cannot but be a cause for concern and explains why one of the five MPC members (considered a hawk) in fact asked for an increase in the policy repo rate by 25 basis points,

In sum, what has played out through the last fiscal and looks to probably get worse in the coming fiscal is a higher amount of uncertainty with higher inflation risks.

On the growth outlook, the MPC resolution is optimistic and expects acceleration in the pace of economic activity in 2018-19. GDP growth is projected to be higher at 7.4 per cent in 2018-19 and in H1 it will be in the range of 7.3-7.4 per cent and in H2 7.3-7.6 per cent. This higher growth is projected on revival in investment activity, due to sustained expansion in capital goods production, improvement in global demand contributing to encouraging exports, and closing output gap.

The MPC resolution way down refers to the twin balance sheet crisis in these words: “…it is especially important that domestic macroeconomic fundamentals are strengthened, deleveraging of distressed corporates and rebuilding of bank balance sheets persisted with, and the risk-sharing markets deepened.” This begs a question: How will this very laudable goal be achieved? If this is read alongside the announcement that the new Indian accounting standards are being deferred, which was also announced today, the message is that the banks are not prepared – not only for accounting standards but equally and maybe more so for a whole new set of changes that are required if balance sheets have to be deleveraged. Unless this is done, the monetary policy becomes weak and redundant. It cannot support the policy objectives of price stability keeping in mind growth.

(Rattanani is a journalist and Pattnaik is a former Central banker. Both are faculty members at SPJIMR)