RBI's rate decision influenced more by core rather than headline inflation

Investors wrong-footed by the hawkish Indian central bank minutes might rather want to train their sights on underlying trends in inflation than the volatile headline number, analysts say.

The Reserve Bank of India, which Bloomberg economists Tom Orlik and Justin Jimenez rate among the top 3 central banks that surprise the most, has a mandate to keep headline inflation around 4 per cent in the medium term. But commentary from members of RBI’s rate-setting panel show they are more focused on core inflation -- the gauge that strips out volatile food and fuel components.

Globally, focus on core inflation is par for course. But in India’s context, it’s the headline inflation that matters, at least until now.

According to the minutes of the April 4-5 meeting released last week, Deputy Governor Viral Acharya said the headline inflation was being influenced by volatile vegetable prices, which according to him wasn’t amenable to monetary policy actions. His panel colleague, Michael Patra, a noted hawk and head of the RBI’s research department, sought an increase in the repurchase rate, citing the stubborn rise in core inflation to above 5 per cent.

“This volatility is largely ‘noise’ from an interest-rate setting perspective,” said Acharya, who heads the monetary policy department. What concerns him more is inflation -- minus food and fuel -- which “one can consider as the ‘signal’ given its persistence.”

The stubborn nature of this inflation gauge along with an optimistic outlook for growth and demand meant Acharya would vote for withdrawal of accommodation in the June policy meeting -- news that sent bond yields soaring. That was a far cry from early April, when bond investors interpreted RBI’s lowering of near-term inflation projections as a signal that interest rates would remain on hold for sometime.

“India’s volatile food prices can often obscure the underlying inflationary trends,” said Priyanka Kishore, lead Asia economist at Oxford Economics in Singapore, adding that investors would do better to keep an eye on the consumer price index excluding food, fuel and motor fuels, which is rising.

Trend
 

At the April policy meet, Governor Urjit Patel lowered inflation projections. The RBI is forecasting inflation for April to September at 4.7-5.1 per cent, slower than 5.1-5.6 per cent made only two months back. It expects the second half inflation to ease to 4.4 per cent, having earlier estimated it at 4.5-4.6 per cent.

India’s annual headline inflation slowed for a third straight month in March to 4.28 per cent from 4.44 per cent in February. That masked an upward climb in core inflation making some policy makers uneasy.

With the current easing in inflation likely to prove temporary, the tone of the minutes show the debate is veering toward a possible rate increase.

“The debate within the MPC has shifted from ‘hold versus cut’ to ‘hold versus raise’ even though the RBI has cut its near-term inflation forecast,” said Rohan Chinchwadkar, assistant professor of finance at the Indian Institute of Management at Tiruchirappalli in southern India. “One reason is the worry that high core inflation will translate to the headline since low food inflation may not sustain.”