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Know What’s Wrong with RBI’s Inflation Forecast; Central Bank Must Not Overlook

Though consensus opinion among economists seems to be that the central bank will not cut repo rates today, but that it will soften its stance right now—and then cut rates in August—what is more important is what RBI chooses to say about its inflation-forecasting methodology. Everyone can, and does, get forecasts wrong, but that it should happen so often, and for even short intervals, is surely worrying.

In October 2016, when headline CPI inflation was at 4.2%, RBI projected March 2017 inflation at 5.3%—inflation had been 6.1% just a few months ago in July 2016. By December, when inflation had continued to fall and was at 3.4%, RBI lowered its March 2017 inflation outlook to 5%, albeit with an upside risk.

For April 2017, the number is down further to 3%. Given that inflation was high in both May 2016 and June 2016—what RBI calls a favourable base effect—it is possible inflation could also be low in May and June 2017. Keep in mind, RBI’s forecast for June 2017—this was made in April 2017—is 4.2%.

One reason why RBI could be getting it so wrong could be the fact that, though the central bank says it doesn’t pay much attention to its household expectations survey, it may just be—otherwise, why not just junk it? The latest survey, interestingly, has a median inflation expectation of 7.5% in FY18!

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