Moving to CPI-based inflation will take at least two years, say experts

This is because a lot of preparations are needed considering a new government will be coming to power soon

Experts have welcomed the Urjit Patel committee’s decision to measure inflation using Consumer Price Index (CPI) to manage monetary policy. However, they believe it could take a couple of years for the Reserve Bank of India (RBI) to switch to CPI-based inflation. This is because a lot of preparations are needed, more so because a new government will come to power this year.

CPI-based inflation came down to a three-month low of 9.87 per cent in December 2013, after touching a record high of 11.16 per cent in the previous month.

“This (moving to CPI-based inflation) was a much-needed shift. An economy can ill-afford elevated inflation for three-four years and, more important, let inflation expectations become entrenched, affecting long-term growth sustainability,” said Shubhada Rao, chief economist at YES Bank. The Street expects status quo on key policy rates in the monetary policy review to be announced next week. This is because along with CPI inflation, even the Wholesale Price Index (WPI) inflation is softening.

“Much depends on the extent to which the governor (RBI governor Raghuram Rajan) will adopt these recommendations. Inferring from Rajan’s emphasis on price stability ahead of the report, the odds that the central bank could adopt the framework in entirety or at least to a large extent, are high. Admittedly, CPI inflation is above the repo rate and it is way above the 12 months’ targeted inflation. Nevertheless, I do not anticipate a knee-jerk tightening next week to rein in inflation. Instead, the lagged impact of 50-basis-point hikes so far and ascertaining the inflation path ahead are necessary inputs before deciding on further rate hikes,” said Radhika Rao, senior economist, DBS Bank.

According to the panel, the transition path to the target zone should be graduated to bringing down CPI inflation from the current level of 10 per cent to eight per cent over a period not exceeding the next 12 months and to six per cent over a period not exceeding the next 24 months period before formally adopting the recommended target of four per cent inflation, give or take two per cent. According to economists, to bring CPI inflation down from the current level to eight per cent is quite achievable. However, beyond that, there is a need for reforms.

“The RBI will target a 4% CPI inflation target (with +/-2% band) in two years. In the interim, the RBI will try to bring down inflation gradually from 10% to 8% over the next 12 months and to 6% over the next 24 months before formally adopting the 4% recommended target. Since food and fuel account for more than 57% of the CPI on which the direct influence of monetary policy is limited, the commitment to the nominal anchor would need to be demonstrated by timely monetary policy response to risks from second round effects and inflation expectations in response to shocks to food and fuel,” said Indranil Sengupta, Indian economist, Bank of America Merrill Lynch.