- Inflation warrior Raghuram Rajan raises repo rate by 25 bps, eases rupee defenceInterest payments: RBI monetary policy review holds some promise for bank account holdersRBI monetary policy review: Bankers unsure on direction of interest rate movesRBI may have done enough on rate hikes: Raghuram Rajan
In its recent monetary policy statement on October 29, Reserve Bank of India published its first ever forecasts of consumer price inflation. This is a significant development. For one, it confirms the central bankís intent to adopt the CPI as its monetary policy anchor. The appearance of retail inflation projections, concurrent with the WPI inflation as the official anchor, has muddled the monetary policy signals emerging from Mint Street. But this is a secondary matter. Primarily, the CPI inflation forecasts themselves raise considerable unease. Not because of the underlying model from which the forecasts might be obtained, or that they might be subjective predictions. The key point is the data available to forecasters: Is there sufficient information for guiding an optimal monetary policy?
Here, the CPI forecasts raise a number of questions. The first of these is to do with data adequacy. The composite CPI is less than three years old, starting from January 2011. To date, i.e., until October, the CPI inflation data points numbered just twenty two. RBIís CPI-inflation forecast could then have been based upon twenty observations perhaps. Is that a long enough time-series for forecasting inflation two quarters ahead? Perhaps the current series was extrapolated backwards with statistical techniques like bootstrapping to overcome data deficiency. How robust are these forecasts in that case?
Other than insufficient data, the predictability of a significant chunk of headline CPI inflation is questionable. The CPI forecasts represent a guess of some prices, viz. food and fuel, which tend to be very volatile. By construction of weights, this variable component is as high as 60% in the price index. What view would the CPI forecasts incorporate of global oil prices and their pass-through to domestic consumers, not really an economic decision? Moreover, food and vegetable prices fluctuate sharply from reasons as diverse as excess or deficit rainfall, other weather vagaries and whether some farm products should be imported or exported, again a political decision. A forecast of this component could be exceedingly complicated and embed a large capricious factor, potentially enlarging the gap vis-ŗ-vis actual outcome.
Apart from the three-fifths variable