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Here Is Why RBI Could Hurt India’s Economical Growth

The moderation of CPI inflation to 3% in April and further to 2.2% in May 2017 has led the market to question RBI’s monetary policy stance and its inflation forecasts. In the absence of any policy interventions and persistence of April trends, RBI projects inflation in the range of 2-3.5% and H2FY18 to 3.5-4.5%, amidst growing criticism of consistently overestimating inflation.

The central bank has expressed caution stating that the recent developments in inflation could be transient and sights rural wage growth, fiscal slippage, farm loan waiver, Seventh Pay Commission allowances as upside risks to inflation.

First, a simple dissection of the retail (CPI) headline numbers is quite intriguing. Food inflation has averaged 1.1% since November 2016, contributing the most to headline CPI disinflation. Core CPI inflation has also moderated from 5% in October 2016 to 4.1% in May.

Vegetable inflation is highly cyclical and any short-term disruptions to the food supply chain impacts food inflation. The current deflation in pulses is more of a correction in a sharp rise in the price of pulses seen in FY16 and H1FY17, thanks to record output and imports.

Food inflation becomes extremely critical in estimating headline numbers, given its huge weight (46%) in the CPI basket. Forecasting food inflation, especially volatile components like vegetables, pulses, etc, has never been easy. Probably this is where most economists, including RBI, have gone wrong in estimating the inflation trajectory. This also explains RBI’s wait-and-watch policy.

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