India’s headline inflation, measured by the Consumer Price Index (CPI), is likely to rise 60 basis points (bps) to 4 per cent this fiscal from 3.4 per cent in fiscal 2019. This base case assumes food inflation rising to 3 per cent from an abnormal low of 0.1 per cent, credit rating agency CRISIL Research said in its latest report.
The CPI-based gauge has now undershot the Reserve Bank of India (RBI)’s medium-term target of 4 per cent for two straight fiscals, and the sharp decline in fiscal 2019 left analysts confounded.
In the report, CRISIL proffers two inflation scenarios for this fiscal:
The upside scenario: If monsoon plays truant, especially in light of an El Niño event, food inflation could surge. Fuel inflation could follow suit if the current uptick in international crude prices persists. Also, core inflation (the part of headline inflation sans food and fuel) could strengthen further on account of the government’s consumption-oriented policies. Together, these could push headline inflation up to 5 per cent.
The downside scenario: On the other hand, inflation could be lower at 3.5 per cent. That would happen if the food inflation remains low for longer, core softens as a result of the lagged impact of economic slack, and government spending remains restrained.
“Our study of the main components of headline inflation and their trends over the past three decades confirms that food has been the main retarding factor,” said Dharmakirti Joshi, Chief Economist, CRISIL Ltd. “Core inflation, which is supposed to be a better gauge of demand-side pressures in the economy, has been fairly sticky downwards, irrespective of economic cycles.”
Fuel, on the other hand, appears to be the most volatile, but given its low weight in the CPI basket, its direct influence on headline inflation is limited. “So far, we note that inflation targeting has coincided with lower inflation and its volatility. Consumer inflation fell to 3.9 per cent per year in three years after implementation of targeting, from an average 7.3 per cent in the four years preceding. Its standard deviation fell to 1.2 per cent from 2.4 per cent,” the report said.
“However, it is important to underscore the significant role of a sharp slowdown in food inflation – an idiosyncratic factor – in driving headline inflation lower. If the RBI’s medium-term target of 4 per cent has to be met, that must sustain,” Joshi added.
The report says while household expectations of inflation have declined after the advent of the inflation targeting framework, their gap from actual inflation has become wider. This is not the first time the Indian economy is witnessing prolonged spells of low inflation. Between fiscal 2000 and 2006, inflation averaged 3.9 per cent, or below the RBI’s current medium-term target of 4 per cent. Inflation in the current low phase (fiscals 2015 to 2019) has averaged 4.5 per cent.