The easing of headline inflation notwithstanding, the central bank is unlikely to abandon its anti-inflationary stance in a hurry.
This is because the ‘base effect’, which has had a strong impact on the inflation outcome during FY14 and is a determining factor in the slide in inflation during the current fiscal as well, is unlikely to wear off conclusively until March 2015. As a result, the CPI (Consumer Price Index) may climb back to around the 8 per cent mark by the end of this fiscal (March 2015), despite the tempering of food prices expected in the next couple of months. Against this backdrop, the RBI is expected to keep the repo rate unchanged until early next fiscal, by when any lasting improvement in the inflation outlook is expected.
Base effect refers to the contribution to changes in the annual rate of inflation from unusual or extreme changes in the price index (or sub-index) during the base period — i.e. the inflation rate during the same month a year ago. So, if inflation was high in the same month last year, then even a spike in prices in the corresponding month this year might appear benign, and vice versa. CPI inflation for August 2014 had declined to 7.8 per cent and, according to Nomura Financial Advisory Services, is expected to ease to 7 per cent when data for September 2014 comes in.
Short-term year-on-year inflation forecasts are fundamentally influenced by the base effect and, according to fresh RBI estimates, favourable base effects are expected to dampen headline inflation over September-November 2014, aided by a moderation in momentum as vegetable prices come off their recent peak.
However, headline inflation, during December 2014-February 2015, are projected to surge sharply as they will “likely be significantly influenced by unfavourable base effects arising out of the sharp fall in month-on-month changes in prices during the base period”.
This, despite a possible subdued momentum from a seasonal softening of vegetable prices, would result in “an upturn in inflation during December 2014-February 2015”.
The base effect is expected to wear off only by early next fiscal. According to the central bank, “monetary policy in disinflationary mode, along with normal monsoons next year could then mute the momentum of headline inflation”.
In its latest policy review on September 30, the RBI had stuck to its neutral tone and extended its status quo on the benchmark rates, despite the CPI inflation trajectory appearing to be on track to meet the early-2015 target of 8 per cent.
The markets, however, have continued to build rate cut expectations, even as the RBI signaled its reluctance to lower rates by shifting focus to the early-2016 target of 6 per cent, after the 8 per cent target appeared within grasp.