Historical oversupplies and huge stocks have meant food CPI has collapsed, so RBI’s model needs to factor this in.
With the economy slowing quite sharply, from 8.2% in Q1FY19 to 7.1% in Q2, and projected to fall to 6.5% in Q4, no one is expecting RBI to raise rates in its policy review later this week since, not surprisingly, CPI inflation continues to collapse, from 5.1% in January to 3.3% in October 2018; the November to January print is also likely to be low if only because the base was higher in the same period one year ago. More important, as has been pointed out before, the central bank continues to get its inflation forecasts dramatically wrong. In FY17, CPI was 4.5% versus the 5% forecast while CPI rose 3.6% in FY18 as compared to the 4.5-5% forecast. In H1FY19, CPI inflation rose 4.3% versus the last projection of 4.7-5.1%; the first projection for H1, made in the February 7 policy review, was an even higher 5.1-5.6%. In which case, the real question is whether RBI was hasty in changing its stance from ‘neutral’ to ‘calibrated tightening’ in the last policy. To be fair to RBI, most independent analysts were calling for a policy hike given how oil prices were rising and the rupee crashing as FIIs withdrew from the country; indeed, with the government announcing high MSPs, it looked as if that would drive CPI through the roof. Today, with crude oil, the rupee and FII flows looking quite different, the inflation outlook looks quite comfortable.
There is, of course, the issue of how much damage RBI’s interest-rate policy has done to the economy since higher interest rates cause growth to slow and make it that much more difficult for corporates and others to service their loans. Apart from the high repo rate, by keeping liquidity too tight—for fear of inflation—RBI ensured yields remained elevated. So, this time around, whether or not RBI changes its stance back to ‘neutral’, it needs to ensure there is enough liquidity in the economy.
For RBI to get its inflation-forecast right, apart from re-calibrating its model, it needs to take a careful look at how it forecasts food inflation; food is 46% of the CPI basket and keeps hitting new lows. While overall food and beverage CPI was a mere 2.4% in January to October this year, it was just 1.8% in Jan-Dec 2017 vs 5.4% in Jan-Dec 2016 and 5.3% in Jan-Dec 2015. The reason for this is the collapse in cereals inflation to 2.6% in Jan-Oct 2018 versus 4.3% in Jan-Dec 2017 and 3.5% in Jan-Dec 2016. Pulses inflation, that was as high as 23-24% in 2015 and 2016, contracted 12.1% in Jan-Oct 2018 on top of an 18.9% contraction in Jan-Dec 2017. Some part of this is due to global commodity prices remaining subdued—global wheat price fell 8% over the last three months, for instance. But more than this is the surge in Indian production. Wheat and rice production rose 6-7% over that five years ago, but pulses rose 38%, sugarcane 29%, vegetables 11% and fruits 19%.
Combine this with the large stocks of 16 million tonnes for rice (that is 14% of annual production) , 33 million for wheat (33% of annual production) and 3.7 million tonnes for pulses (15% of production)—and the government’s willingness to use this to control prices, unlike in the past—and it looks as if India is looking at a secular dampening of food prices; more so since, despite all the promises, there is little procurement by government agencies and, as a result, it doesn’t look as if the MSP plan is going to work. RBI’s new food model will have to build in the impact of high stocks, look at ratios like stocks-to-consumption, and so on. Till RBI gets its food inflation forecasts right, it will continue to get its CPI forecast wrong.