Column: Under the RBI lens

Sep 02 2014, 02:08 IST
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SummaryGiven the Urjit Patel monetary policy framework said household expectations were closely correlated with CPI-inflation, it is puzzling RBI should now seek to dilute the significance of household surveys.

Anchoring inflation expectations is central to the inflation targeting framework. That is because it is through the expectations channel that beliefs morph into actual inflation—if agents’ inflation expectations are high or rising, these will manifest in wages and price-setting by workers and producers. Monetary policy, therefore, seeks to influence expectations such that they are anchored around a pre-committed inflation target; temporary deviations from the target then dissipate with no second-round effects in the belief the central bank will take appropriate policy actions to keep inflation close to the objective. In other words, temporary price shocks do not spill over into a generalised price increase if the central bank’s monetary policy is credible.

Eight months into an informal adoption of inflation targeting with headline CPI as nominal anchor, there are signs of discomfort in RBI about the evolution of inflation expectations in India. As per the latest survey of households (HH), inflationary expectations persisted at higher levels in spite of headline CPI declining quite sharply. RBI seemed a little puzzled as median expectations for current, 3-month and 1-year ahead inflation in April-June 2014 came in at 13.3%, 14% and 15%, respectively, as against 13.3%, 12.9% and 15.3% in the previous (January-March) quarter. At the post policy conference call on August 6, RBI Governor admitted that disinflation has not shown up as yet in inflationary expectations and he would not take the level of these surveys as Gospel truth. Not surprisingly, he pointed out that policy would be more driven by actual inflation than by these survey inflationary expectations.

Barely weeks down the line, RBI’s Annual Report (Box II.3) went a step further in diluting the significance of the outcomes of the household surveys and instead, displayed a marked preference in favour of professional forecasters’ (SPF) survey, which shows moderating medium- and long-term inflation expectations. As per the latest SPF, 5-year and 10-year ahead median expectations for CPI inflation declined to 7% and 6% respectively in April-June, from 7.75% and 7% the previous quarter; in line with the medium-term CPI inflation target of 6% by January 2016. The report emphasised that as the professional forecasters consider all the available information, past and future, their expectations could be considered more rational than that of households.

This was bit of a surprise given the fact that the Urjit Patel committee report on the new monetary policy framework (UPC) presented clinching evidence of high

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