Wrong Numbers

RBI’s inflation forecasts have been more misses than hits, says chief economic advisor

The Economic Survey pointed out how the central has been overestimating inflation risk for years.

The Reserve Bank of India has had more misses than hits when it comes to predicting inflation, Chief Economic Advisor of India Arvind Subramanian said in the second volume of the Economic Survey, tabled in Parliament on Friday.

The RBI’s monetary policy committee, with a mandate of targetting inflation to keep it below 4%, meets every two months to discuss projections and decide whether to change the prevailing interest rates in the economy. However, recent policy meetings have shown that the committee’s judgement on inflation is often off the mark.

Subramanian pointed out that the RBI got its inflation projections wrong by more than 100 basis points (one basis point is 1/100th of a percent) for six out of the last 14 quarters. Three of these projections were in 2014 and the rest were in the most recent quarters ended June 2017. The Economic Survey pointed out that most of these were very short term forecasts, for just three months ahead. The RBI also offers mid-term projections for up to six months and long-term ones, for up to 18 months.

RBI's forecast for consumer price index versus actually observed inflation
RBI's forecast for consumer price index versus actually observed inflation

The RBI’s forecast was within 50 basis points of the outcome in another four quarters and within 25 basis points in one quarter.

However, the chief economic advisor said that imperfect inflation forecasting is not limited to the RBI. The Economic Survey said that consumer price inflation has undershot professional forecasts “fairly consistently” over the last five years in the rest of the world as well.

Why can’t the RBI get inflation forecasts right?

This is not the first time that the RBI has been criticised for its policy decisions based on faulty inflation forecasting.

On August 2, when the central bank cut the repurchase or repo rate – the rate at which it lends to banks – by 25 basis points, its monetary policy committee was divided on the decision. While four of the members favoured a rate cut, one called for status quo and another member recommended an even bigger cut, by 50 basis points. The decision, though widely expected, was in sharp contrast to the its resolution in June and experts pointed out that RBI’s monetary policy committee had cited the same economic outlook as a reason not to reduce rates in its previous meeting two months ago.

Earlier this year too, experts had pointed to seeming inconsistencies in the RBI’s decisions as the bank persistently kept repo rates constant even though inflation continued to fall.

Subramanian had also earlier questioned the monetary policy committee’s decision to keep repo rates unchanged in its last two meetings in June and April even though inflation had been steadily decreasing and a slowing economy could have done with a liquidity boost.

While announcing the rate cut earlier this month, the RBI had said that inflation in June stood at a record low of 1.54%, giving it leeway to reduce rates. However, the Economic Survey points out that low inflation rates might be the new normal for India, at least in the near future.

“Actual lesser inflation than forecast could well reflect the extraordinary developments such as the durable collapse of international oil prices,” the Survey said.

The chief economic advisor argued that with the introduction of new technologies and of shale as an alternative to crude oil could keep oil prices low in the global markets, thus reducing the risks to commodity prices in India and keeping them somewhat stable.

The survey said: “In sum, geopolitical risks are simply not as risky as earlier. Technology has rendered India less susceptible to the vicissitudes of geo-economics (OPEC) and geo-politics (Middle East). If and to the extent that changes prove permanent, the consequences for the inflationary process need to be taken into account.”

At the same time, the survey took note of the government’s efforts to contain inflation and said that the low inflation levels were a “historic moment” that instills confidence in price stability – something that the RBI has been trying to achieve for years.

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