Even at 4.25% inflation rate, Das sees disinflation process as protracted

Waning of base effect and uncertainty over monsoon may come in the way of disinflation, going forward

At the outset, Reserve Bank of India (RBI)'s Governor Shaktikanta Das' statement that the process of retail disinflation would be slow and protracted even as the inflation rate fell to a 25-month low of 4.25 per cent in May seems surprising. The inflation rate is quite close to RBI's target of four per cent but even then the governor said the central bank may meet its goal on inflation only in the medium term.

This also seems surprising because the wholesale price index (WPI) was in deflation for the second month in a row at 3.48 per cent in May. This may also have an effect on retail price inflation in the coming months, it seems.

However, when one does a deeper analysis, the RBI governor's statement would seem appropriate.

While the retail food and fuel inflation rate came down drastically in May, the core inflation (that relates to non-food and non-fuel items)  inched down slightly to 5.7 per cent in May from 5.8 per cent in the previous month.

The food inflation rate fell to an 18-month low of 2.91 per cent in May and fuel and light inflation declined to a 26-month low of 4.64 per cent.

However, the core inflation rate remained in the range of 5-6.5 per cent for at least 29th months in a row.

It should be noted that here core inflation is calculated by keeping food items, fuel, and light as well as petrol and diesel used in vehicles out of it.

While core inflation remained sticky, there is considerable uncertainty over the monsoon due to developments related to El Nino, which may affect food inflation.

Anil K Sood, professor, and co-founder of The Institute for Advanced Studies in Complex Choices, said the RBI governor’s statement on inflation is not surprising as inflation in India, like elsewhere, has multiple parents.

In some of these cases, the RBI has no or limited influence but is still expected to ensure price stability, he said.

"For example, core inflation is largely determined by producer pricing power and fuel, edible oil and metal prices in India depend on global commodity prices. Global commodity prices are, in turn, dependent on advanced economy's interest rates. RBI can not do much in both of these situations," Sood said.

The relentless increase in global commodity prices between April 2020 and March 2022 coincided with the near-zero policy rate in the US and European economies. The prices had more than doubled (118 per cent increase) during the above period. Once the US Federal Reserve started raising rates in March 2022 and it became certain that it would not relent, the commodity prices declined by about 34 per cent, according to Sood.  

Bank of Baroda Chief Economist Madan Sabnavis said most of the low inflation numbers are being driven by high base effects.

"A couple of negative inflation numbers for oil and vegetables have brought down food inflation. These trends will change from the second quarter onwards and RBI projections are 5.2 and 5.4 for the next two quarters. Therefore, it will take a long time before inflation stabilizes towards four per cent," he said.

The RBI's monetary policy committee (MPC) projected the inflation rate in the remaining three quarters to rise in the range of 5.2-5.4 per cent with the entire year yielding it at 5.1 per cent.

If that happens, bringing it down to four per cent would take beyond this financial year.

Icra Chief Economist Aditi Nayar said, "With the base effect, we expect consumer price index (CPI)-based inflation to harden in the next few months. The MPC's quarterly forecasts peg inflation above five per cent in the next three quarters."

Whether El Nino materialises and the subsequent alacrity on food management would be some factors that would guide the inflation trajectory in the second half of the year, she said.  

Sood said, "In India, we experienced double-digit annual growth in inflation of edible oil (15 per cent) in 2020 and 2021 and fuel and light (12 per cent) in 2021 and 2022, sometimes with a lag caused by policy interventions like reduction in import tariff or not raising petrol and diesel prices around election time."

In markets, represented by Miscellaneous and Clothing and Footwear sub-groups, where the producers enjoy pricing power, the CPI inflation has been between 6-7 per cent since 2019, he said.

The housing market, on the other hand, has been on the RBI’s side in its struggle to ensure price stability, with average inflation being just 3.7 per cent between 2020 and 2022. It may not remain a bright spot, as the current year (2023-24) inflation is at 4.8 per cent so far.

"Given that we are heading for general elections in a year’s time, I do expect the RBI to be cautious in its actions as well as its words. It must manage inflation as well as inflation expectations, particularly in a situation where we expect the Indian economic growth to be just around 6.5 per cent and we are yet to get a clear picture of growth in China, Europe, and the US," Sood said.