At 6.7%, RBI’s inflation forecast could be an optimistic one

The central bank on Wednesday raised the inflation forecast by 100 basis points, up 220 basis points in a matter of two months – the sharpest since RBI adopted flexible inflation targeting as a formal monetary policy objective in 2016. But it may be a conservative estimate given that the assumed crude oil price, at $105 a barrel, may have to be raised.

Even as RBI has retained its growth forecast for FY23 at 7.2%, it has raised the inflation forecast by 220 basis points to 6.7% for FY23 above its tolerance band of 2-6%.

But these estimates factor in oil prices at $105 per barrel versus $120 dollars per barrel prevailing now. According to analysts, a $10 a barrel change in crude prices could impact CPI inflation by 50-60 bps.

The generalised surge in the international prices of food, energy and industrial items that began around the war in Europe has not abated, according to Dharmakirti Joshi, chief economist at ratings firm . “This will put pressure on domestic food, fuel and core inflation,” he said.

The latest Inflation Expectations Survey conducted by the Reserve Bank of India indicates that households’ median inflation perception for the current period increased by 40 bps when compared to March 2022 round of the survey, whereas it increased by 10 bps and 30 bps for the three-month and one-year ahead periods, respectively.

The RBI governor has stated that 75% of the increase in CPI forecast is due to food items. Global developments on food and commodities prices are expected to play a key role in determining CPI inflation. “We expect the 10-year bond yields to trade in the band of 7.40 %- 7.60 % in the coming months” said Murthy Nagarajan, head – fixed Income, Tata Mutual Fund.

Besides, there are several domestic parameters that have not been adequately factored in.

“There are several upside risks to inflation in the near-to-medium term, from commodity, food, MSP increases, electricity tariff hikes, services sector and pending pass-through from WPI inflation” said Kaushik Das, chief India economist at Deutsche Bank. “Therefore, it is possible that FY23 CPI inflation can end up being higher, even after RBI’s steep upward revision.”

The Reserve Bank seems to prefer to tread cautiously.

“Monetary policy measures take six to eight months to fully play out,” said governor Shaktikanta Das at the post-policy press conference in Mumbai. “We will watch the situation. We can’t provide any guidance as the situation is very uncertain.”

The RBI expects inflation to average above the 6% upper tolerance level for the first three quarters of FY23.

“We believe inflation could be even stickier, averaging north of 6% for all the 4 quarters of the year,” said Pranjul Bhandari, chief India economist, HSBC. “We agree that growth momentum is strong currently, led by a wave of pent-up demand; but may slow in 2HFY23 as the wave runs its course and urban inflation rises, hurting purchasing power.”

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