Indian Central Bank An Outlier In Skipping Inflation Forecasts

Globally, most inflation targeting central banks have provided forecasts for inflation amidst the pandemic.

New electric automobiles. (Photographer: Luke MacGregor/Bloomberg)
New electric automobiles. (Photographer: Luke MacGregor/Bloomberg)

For the third consecutive meet since the outbreak of the Covid-19 pandemic, the Indian central bank has stayed away from providing growth and inflation forecasts. The lack of such forecasts, particularly inflation, makes it tougher to judge the future path of monetary policy, say economists, even though they acknowledge the difficulties in assessing the economic outlook amid disruptions caused by the pandemic.

India formally moved to an inflation targeting regime in 2015, under which the Monetary Policy Committee is mandated to bring down inflation to 4%, within a tolerance band of +/-2%.

“Inflation forecasts, by acting as an intermediate target, play a special role in an inflation-targeting framework,” according to a research paper titled, “Inflation forecasts: Recent experience in India and a cross-country assessment” published by the RBI in May 2019. If the medium-term inflation forecasts are above the inflation target, they signal the need for a monetary tightening to bring inflation back to target level, the paper explained. Hence, consistently reliable forecasts of inflation facilitate a sustained attainment of desired policy goals, it added.

Despite this central role of inflation forecast, the RBI and MPC have only provided directional guidance on inflation.

To be sure, the legal mandate in the RBI Act requires the central bank to publish a Monetary Policy Report only twice a year, which includes inflation forecasts for the period between six to eighteen months from the date of publication of the document. The last such document was published in early April when the Covid crisis had only just hit the country.

Until before the Covid crisis hit, the MPC would detail its inflation forecasts in each resolution.

Not Once, Not Twice But Three Times

It is understandable that these forecasts were not released in March and in May, said Kaushik Das, chief economist at Deutsche Bank. Since then, Consumer Price Index inflation estimates for April-June 2020 have been released using an imputed methodology.

“We were expecting that the RBI would give a forecast range so that we could make out what is the level of uncertainty around inflation expectations and when we should anticipate the next rate move, if there is a chance of a further rate cut or if the cycle is over,” Das said.

Typically it’s unusual for an inflation targeting central bank or for the MPC to decide on policy rates without forecasting inflation and GDP growth rates for the short, medium and long term horizons, said Rajeshwari Sengupta, assistant professor at Indira Gandhi Institute of Development Research. Inflation targeting, at the end of the day is effectively about targeting inflation forecasts, she said.

However, Sengupta acknowledged that these are not usual circumstances. Collection of inflation and output data in the first few months of the lockdown was disrupted. This would have significantly hampered the forecasting by MPC, Sengupta said.

However now that more data have become available, in the latest meeting, the MPC could have based their decision on forecasts. While they qualitatively discussed the upside and downside risks to inflation and growth, in absence of quantitative projections, it might be difficult for the markets, investors and the like to understand the basis of their policy decision and form inflation expectations for the future.
Rajeshwari Sengupta, Assistant Professor, IGIDR

Partha Ray, professor of economics at the IIM-Calcutta, said while absence of an estimate could be against the letter of an inflation targeting framework, in spirit, the RBI is on solid grounds.

“The key to understanding future growth and inflation lies crucially on the future trajectory of the pandemic and its resolution, and till the time we have affordable vaccines that scenario is shrouded in huge uncertainty,” Ray said. “Hence, it may not be proper for RBI to commit to a precise number.”

“It is better to be roughly right than precisely wrong”, said Ray, quoting John Maynard Keynes.
Monetary Policy: A Tilt Back Towards ‘Normalcy’

What Other Economies Have Done

A number of economies have faced lockdowns and sudden data disruptions due to the Covid crisis. Most have continued to give out forecasts for growth and inflation.

Other central banks in Asia — Indonesia, Malaysia, Philippines — that target inflation have published their range for GDP and inflation forecasts in 2020, said Priyanka Kishore, head of India and South East Asia macro and investor services at Oxford Economics. “Current circumstances do make forecasting growth and inflation much more challenging as evident from the frequent forecast revisions from economists. The same situation, however, also makes it more important to have timely update forecasts to guide policy setting,” Kishore said.

Sergi Lanau, deputy chief economist at the Institute of International Finance, said many central banks have published multiple scenarios or a reduced set of forecasts given the exceptional circumstances. In case of India, the monetary policy statement does discuss inflation at length, even if point forecasts are missing, Lanau said.

“The overall message seems clear to me: we can expect an extended period of accommodative policy but the MPC wants to wait and see if the recent spike in inflation fades before considering more easing,” Lanau said. “I see the language they are using as a way of saying, we are ready to “see through” this inflation spike that comes from lockdown-related supply disruption but we are pacing ourselves.”