RBI lowers retail inflation forecast despite crude oil shock

At a time when crude prices are threatening inflationary pressure in the economy, the Reserve Bank of India (RBI) has thrown a surprise by lowering the consumer price index (CPI) or retail inflation projection from a high of 5.7 per cent to 5.3 per cent in the current fiscal.

The RBI has revised the inflation projection downward for the second quarter from 5.9 per cent to 5.1 per cent. The third quarter ( Oct-Dec) forecast has been revised from 5.1 per cent to 4.5 per cent. The fourth-quarter inflation projection has been kept at 5.8 per cent.

The central bank's confidence comes from the gradual decline in retail inflation from a high of 6.6 per cent in May to 5.3 per cent in August 2021. 

Also Read: RBI MPC Meet Outcome Highlights: No repo rate cut; FY22 GDP growth seen at 9.5%, CPI pegged lower at 5.3%

The RBI is still maintaining that inflation is transitory and a temporary phenomenon because of supply-side shocks from the pandemic lockdowns. 

Morgan Stanley Research also expects headline CPI to moderate to 4.3 per cent in September from 5.3 per cent in August, driven by base effect and low food inflation. 

Most experts cite the easing of food inflation in view of comfortable Kharif food grains and also the rising number of vaccinations in the country as favourable factors for the downward inflation trajectory.

But a section of the market is surprised as crude oil prices are already flaring up in the international market. Crude prices are currently close to $80 per barrel. 

There is already a direct impact on the domestic petrol and diesel prices. Take, for instance, the petrol prices in Mumbai have breached Rs 109 per litre, while diesel prices increased to Rs 99.55 per litre. 

The petrol and diesel prices are moving up across the country.  At some stage in future,  the high transportation charges are going to fuel inflation in food and other items in the second half of the current year.

"While food inflation is expected to remain low, we believe there is a case to monitor inflation very closely over the next few months given the continuing commodity price pressures, industrial raw material shortages and the impending recovery in consumer demand," says Suman Chowdhury, Chief Analytical Officer at Acuité Ratings & Research.

Also Read: RBI keeps repo rate unchanged, maintains accommodative stance

Globally, inflation has been on the rise in developed and emerging markets. There are some central banks especially Brazil and Mexico that have already started increasing the interest rates to contain the inflationary pressure.

A lower inflation forecast provides headroom for RBI to continue with the accommodative stance with lower interest rates. The country's apex bank has been maintaining the repo rate at 4 per cent for the last year to support the industry as well as households and also support the overall recovery in the economy. 

Repo rate is the rate at which the banks borrow funds from the central bank. The RBI's monetary policy committee has the mandate to keep inflation at 4 per cent with a band of 2 to 6 per cent. 

Retail inflation has averaged 6 per cent in the first pandemic year. The revised projection of 5.3 per cent in the current year is encouraging if it stays within the 6 per cent level.

"What we are doing is spreading the disinflation over a period of 2-3 years so that the losses of output are minimised. That's the inflation stance," says Michael D. Patra, RBI's Deputy Governor in the August policy.

Jayanth R. Varma, one of the MPC members, had warned in the August policy that the inflationary pressures are beginning to show signs of greater persistence than anticipated earlier. 

"While there is some comfort that inflation is forecast to be below the upper end of the tolerance band, it is important to emphasise that the inflation target for the MPC is 4 per cent and not 6 per cent or even 5per cent," he said.

Varma added that the tolerance band is designed to allow for forecast errors, implementation shortfalls, and measurement issues. "Treating 5 per cent as the target would significantly increase the risk of inflation targeting failures," he noted.

If the oil prices continue to rise, the RBI will need support from the government in reducing cess and excise duties to reduce the cost pressures coming from oil prices. There are some estimates of oil touching $100 a barrel.