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CPI at 6% by 2016? RBI’s Rajan at mercy of these 3 factors

The News International Team

Deficient monsoon and thereby spiking food prices indicate Reserve Bank of India (RBI) Governor Raghuram Rajan’s battle against inflation is far from over. Addressing the media after annoucing RBI’s recent bi-monthly monetary policy, inflation-wary Rajan said risks to achieving the target of sub-8 percent CPI inflation by January 2015 remained. He kept key policy rates unchanged.

The central bank chief has been on a war-footing against inflation ever since he took office in September last year and has raised rates thrice since then. As food inflation had begun cool off, El-Nino fears and below normal monsoon pushed prices higher. Also, geopolitical tensions in oil exporting countries Iraq and Libya, led to supply disruptions spurring global crude oil prices, added fuel to the inflation fire.

Also Read: What IMD’s monsoon forecast downgrade means for our economy

Rajan, a former International Monetary Fund (IMF) chief economist, aims to bring inflation to 6 percent by January 2016. But is it attainable? Yes, if these three pre-conditions are met. 

In its recent report, Bank of America Merrill Lynch says normal rains hold the key to the RBI’s 6 percent January 2016 target. A 5 percent swing in agro prices impacts CPI inflation by about 250bp. “We reiterate our view that CPI inflation is peaking. At the same time, poor rains pose an immediate 200bp risk. We do not agree with the pessimism now that it is rising again. After all, the key drivers of non-food CPI inflation – oil, rupee, rentals – are all reversing. Overall, this points to a possibility of CPI inflation coming-off by 200 plus bps in FY16 from current levels of 8 percent,” it adds.

Secondly, the research firm expects “imported” inflation from oil prices to subside. “If Brent does not go beyond USD 108/barrel, as our oil strategists expect, in 2015, the government could complete the pass through to domestic diesel prices latest by June 2015,” it explains.  BofA ML sees Brent at USD 100/barrel by 2018.

Finally, it says that RBI can calm down “imported” inflation by stabilizing the Indian rupee. BofA ML expects the central bank to continue to recoup forex reserves to hold Rs 58-62/USD, assuming that the US Dollar settles at 1.30s/Euro. “We have estimated that 5 percent depreciation impacts CPI inflation by 100bp. As the rupee has appreciated nearly 13 percent in the last year, we estimate that an additional 50bp of this positive pass through effect is yet to come,” says the report.

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