Explained: Reasons why RBI cut its retail inflation forecast for 2019

The Reserve Bank of India (RBI) on Thursday cut the retail inflation forecast to 2.9-3 per cent for the first half of current fiscal, mainly due to lower food and fuel prices as well as expectation of a normal rainy season. However, the central bank voiced uncertainty over inflation outlook.

In its previous policy outcome in February, the RBI had projected retail inflation between 3.2-3.4 per cent for the first half of 2019-20.

Here are the reasons why the RBI has cut inflation forecast

First, low food inflation during January-February will have a bearing on the near-term inflation outlook.

Second, the fall in the fuel group inflation witnessed at the time of the February policy has become accentuated.

Third, CPI inflation excluding food and fuel in February was lower than expected, which has imparted some downward bias to headline inflation. 

Fourth, international crude oil prices have increased by around 10 per cent since the last policy. 

Fifth, inflation expectations of households as well as input and output price expectations of producers polled in the Reserve Bank’s surveys have further moderated. 

Beyond the near term, several uncertainties cloud the inflation outlook, said RBI

1. El Nino effects, reversal in vegetable prices

With the domestic and global demand-supply balance of key food items expected to remain favourable, the short-term outlook for food inflation remains benign. However, early reports suggest some probability of El Nino effects in 2019. There is also the risk of an abrupt reversal in vegetable prices, especially during the summer months. 

2. Uncertainty about inflation in fuel items

Second, inflation in fuel group items, particularly electricity, firewood and chips saw unprecedented softening in H2:2018-19. There is, however, uncertainty about the sustainability of this softening in inflation in fuel items. 

3. Outlook for oil prices continues to be hazy

Third, the outlook for oil prices continues to be hazy, both on the upside and the downside. On the one hand, continuing OPEC production cuts will reduce supplies. On the other hand, there is considerable uncertainty about demand conditions. Should there be a swift resolution of trade tensions, a pick-up in global demand is likely to push up oil prices. However, should trade tensions linger and demand conditions worsen, crude prices may fall from current levels, despite production cuts by OPEC. 

4. Slowdown in economic activity may impact outlook for food inflation

Fourth, inflation excluding food and fuel has remained elevated over the past twelve months with some pick up in prices in February. However, should the recent slowdown in domestic economic activity accentuate, it may have a bearing on the outlook for inflation in this category. 

5. Volatility of global financial markets

Fifth, financial markets remain volatile reflecting in part global growth and trade uncertainty, which may have an influence on the inflation outlook.