Even as RBI’s inflation forecasts mostly remained on target, it missed them on two occasions due to unexpected shocks arising from food prices such as vegetables. The projection errors were first noticed following demonetisation and second between 2015 to 2017, when the prices of pulses dropped sharply after rising by 50 per cent, said a report by RBI’s Monetary Policy Department.
The report stated that during April to June 2016, vegetable prices rose only to stabilise by October 2016 ona cocunt of robust seasonal surge in the tomato prices. However, soon after demonetisation, a significant dip in the prices of vegetables was seen.
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Similarly, the prices of pulses that rose by nearly 50 per cent between January 2015 to July 2016, began to ease in the third quarter of FY17. The prices declined further by nearly 20 per cent in the fourth quarter from the July-level, the report said.
This steep decline was in a stark contrast to the trends seen historically, the report also mentioned. Adequate rainfall, better supply side decisions taken by the government, increase in stock limit of pulses, higher MSPs, among others, were a few factors behind the sharp decline in the prices.
The divergence from actuals may occur on account of change in the initial conditions and rise in volatility in the baseline assumptions, the report added. In addition to a sharp dip in food inflation, deviations may also happen due to other variables including crude oil prices, it noted.
There is a significant correlation of forecast errors with the composition of the food items in the CPI basket, the RBI report said.
India took to an inflation-targeting mechanism to RBI monetary policy in 2016. A target of 4 per cent with a range of +/- 2 per cent for the period from August 2016 to March 2021 has been established as a medium-term inflation target by the government.