Decoding MPC's shifting stance on inflation

RBI Governor Urjit Patel along with deputy governors Viral Acharya, SS Mundra, N S Vishwanathan and BP Kanungo during a press conference announcing the Reserve Bank of India's monetary policy at its headquarters in Mumbai
Over the course of the last two monetary policy reviews, there has been a marked shift in the monetary policy committee’s (MPC’s) assessment of the inflation dynamics in India.

Not only has the committee lowered its inflation forecast for FY18, but its assessment of the risks to inflation has also seen a change. 
Take the case of services inflation.

Based on data till February, the April policy statement had argued that “underlying inflation pressures persist, especially in prices of services”.

Two months later, it now says that “inflation in respect of services embedded in transport and communication, education, recreation and health also moderated”. This change in stance appears to be based on a single month’s data. CPI data show that inflation in the “miscellaneous category”, which largely comprises services, was hovering around 4.8 per cent in February and March. It only declined to 4.25 per cent in April.

Within this category there does not appear to be a secular trend across various categories.

Education inflation in April had actually risen up to 5.32 per cent from 5.2 per cent in March. It was 5.37 per cent in February. Inflation in health services had declined but only marginally from 4 per cent in February to 3.98 per cent in April. Only recreation had fallen from 3.57 per cent in March to 3.3 per cent in April.

 
The transport and communication segment had seen the largest decline, falling from 6.05 per cent in March to 4.01 per cent in April. This was largely on the back of moderation in petrol and diesel prices.

But this decline is likely to be reversed as the MPC itself notes that “accumulated downward adjustment in the prices of petrol and diesel effected in April has been largely reversed on June 1”.

On the impact of the goods and services tax (GST) on inflation, the April policy statement had said that “upside risk arises from the one-off effects of the GST”. 
But now it says that the “implementation of the GST is not expected to have a material impact on overall inflation”.

It is possible that as in the interim the GST Council finalised the tax rates under the new indirect tax regime, the MPC now has a better understanding of its impact on inflation.

“The latest policy announcement is after the GST rates were announced. The MPC now believes that the roll-out will be neutral for inflation. This is in line with market expectations,” said Suvodeep Rakshit, senior economist, Kotak Institutional Equities.

But other experts aren’t so sure.

“The MPC believes that the GST will not have material impact on inflation. This is based on their own conjecture. I’m not so sure,” said Madan Sabnavis, chief economist at CARE ratings.

On core inflation, the MPC believes the fall in April might be transient due to the “underlying stickiness in a situation of rising rural wage growth and strong consumption demand”. Core inflation has eased to 4.4 per cent in April down from 5 per cent in March.

Data on rural wages from the labour bureau seem to corroborate the view of rural wage growth. Rural wages for occupations such as ploughing, tilling and sowing have grown by around 7.3 per cent in February, up from 6.2 per cent in January.

But whether this is transitory and sufficient to boost aggregate demand is debatable for two reasons.

First, despite this growth, real wage growth still remains depressed said Pronab Sen, former chief statistician of India.

Second, much of this spurt is related to the sharp increase in person days of work under the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA). The two are correlated. Person days of work grew from 88 million in November to 220.5 million in February. But as work under MGNREGA is cyclical in nature, the strong rise in wage growth may not be sustainable going forward.

Changing view

 
Over the course of the last two policy reviews, there has been a shift in the MPC’s assessment of the inflation dynamics in India. The committee lowered its inflation forecast for FY18. Also, its assessment of the risks to inflation has also seen a change.