Objective of durably aligning inflation with target far from assured

Dashing hope for any reduction in policy repo rate in the near future, the Reserve Bank of India’s (RBI’s) state of the economy report pointed out that a combination of factors poses a risk to inflation, and as a result, aligning inflation to the 4 per cent target is far from assured.

The target for the central bank is to maintain inflation at 4 per cent, with a band of 2 per cent on either side.

The report said the softer inflation prints for September and October and the prolonged pause in the monetary policy stance have engendered a certain ‘hypermetropia’ among some stakeholders — ‘an irrational long-sightedness’ whereby inflation forecasts gravitating towards the 4 per cent target sometime in the distant future are sighted clearly whereas high near-term risks of spikes in inflation outcomes on the back of food volatility are blurred.

The report said monetary policy should have to respond if food inflation as a whole becomes lastingly elevated and sends secondary impulses across other prices.

“Under these conditions, a clamour rises for rate cuts or at least that the central bank commits to a path of moderation in the level of the policy rate,” it said.

Such views imperil the conduct of monetary policy in the pursuit of its goal of durably aligning inflation with the target, the report commented while citing the RBI’s projection of inflation, which is 5.6 per cent for the current quarter, and 5.4 per cent for 2023-24. The RBI projects inflation for the first three quarters of 2024-25 at 4.6 per cent.

“The objective of aligning inflation with the target on a durable basis is far from assured,” the report said.

The report said the Consumer Price Index (CPI) inflation rose to 5.6 per cent in November as the recurrence of food price spikes punctured a brief respite in September and October, but it is expected to ease to 4.6 per cent in the first three quarters of 2024-25. Domestic financial markets have been lifted by the abiding strength of the real economy, it said.

The main risk to the outlook stems from the evolution of inflation in the months ahead, it said.

Among the risks, the report said households’ inflation expectations are still not settled; business and consumer confidence in the inflation outlook is yet to turn optimistic.

The report also said inflation is hurting discretionary consumer spending and this, in turn, is holding back the top line growth of manufacturing companies as well as their capital expenditure (capex).

“If inflation is not brought back to the target and tethered there, there is a strong likelihood that growth may falter,” it said.

Observing that the innate strength of the economy is the stability of the Indian rupee (INR), the report said on a trade-weighted basis, the nominal value of the INR has undergone an appreciation by 1.6 per cent during 2023-24 (April-December 8).

Adjusted for inflation differentials, the INR’s appreciation is even higher at 4.5 per cent. Over this period, the US dollar has appreciated by 1.5 per cent against a broad index of currencies.

“The strength of the INR reflects no less to the active hands-on management by the RBI in allowing the currency to find its level in a market-determined manner but in eschewing volatility in a time of formidable global spillovers and an extremely uncertain international environment,” the report said.

KEY NOTES

> Growth to falter if inflation not sustained at target

>RBI projects inflation for the first three quarters of FY25 at 4.6%

>Households’ inflation expectations still not settled

>Business and consumer confidence in the inflation outlook yet to turn optimistic