Despite a sharp reduction in its inflation forecast, the MPC’s policy stance has been kept neutral citing inflation risks on which they seek more clarity. Yet, we believe, given the likely undershooting of inflation, the ‘neutral’ stance has a de-facto softening bias. Our inflation forecast is lowered to 4% (down from 5% earlier) for fiscal 2018, given the downside from food inflation. We now assume increased chances of a 25 basis points (bps) repo rate cut, most likely in the August MPC review meeting.Inflationary pressures have reduced dramatically in the last several months, with food inflation (especially pulses and vegetables) being the key driver. The latest inflation print (for April 2017) was 3% with food inflation at 0.6%. Latest estimates by the Ministry of Agriculture suggest that growth in food grain production, at nearly 9% in fiscal 2017, was the highest in six years, with pulses production rising 37% on-year. For fiscal 2018 too, agriculture production is expected to stay healthy given the Indian Meteorological Department’s (IMD) rainfall forecast of 98% of normal. Lack of clarity on three key factors is probably behind the MPC’s decision to maintain caution.
One, the distribution of rainfall. The IMD has forecast normal rains but past instances show that evenly distributed rains are equally crucial. Clarity on that will only emerge as the monsoon season progresses. Second, the impact of revision in house rent allowance on inflation trajectory also remains unknown. With a weight of 10% in CPI, housing inflation at over 5% is already a concern. The MPC estimates that if the recommended increase in HRA is adopted, just the direct impact on CPI could be to the tune of 100-150 bps over their forecast. Three, resilience in private consumption demand even during the demonetisation phase, and uncertainty of its persistence reduces clarity on the core inflation (inflation excluding food and fuel items) trajectory.
The author is chief economist at Crisil