The Indian central bank’s tendency to overestimate inflation has prevented it from cutting interest rates further and cost the economy, according to one of Prime Minister Narendra Modi’s advisers. “Their view of the economy doesn’t seem to be correct,” and by keeping rates high, they “have imposed a high output sacrifice,” said Ashima Goyal, a member of Prime Minister’s Economic Advisory Council. “They believe inflation will rise, but you know their predictions of inflation have always been overestimated.” While the central bank’s CPI forecasts are wrong, its notion that keeping rates higher will anchor inflation expectations has also worked against them and proved to be a drag on growth, Goyal said in an interview last week. The RBI has room to reduce rates by 100 basis points as CPI will remain within its target range of 4 percent plus/minus 2 percent and as India doesn’t need real rates of more than one percent, she said. The RBI did not respond to an email or phone call seeking comment. “They have been working through the aggregate demand channel to reduce inflation but aggregate demand channel is weak in India,” said Goyal, who earlier served as a member of the RBI’s technical advisory committee on monetary policy. Decreasing aggregate demand, “decreases output, and has the first effect on output and little effect on inflation.” The $2.3 trillion economy is likely to grow 6.5 percent this fiscal year as consumption and investment remain sluggish, she said. That would be the slowest pace of growth since 2014. Data last week showed gross domestic product grew 6.3 percent in the July-September quarter, rebounding from 5.7 percent in the previous quarter. “The recovery is there but it’s not large,” she said. “There are demand constraints. So, therefore, whatever space there is — fiscal, monetary — should be used.”
Inflation will remain under control due to a “secular downtrend in commodities,” better supply management of pulses by the government, improvements in agricultural marketing and the expectation that oil prices will remain lower, she said. “The RBI has over-delivered on its inflation mandate,” said Abhishek Gupta, Mumbai-based India analyst with Bloomberg Economics. “Structural reforms are lifting potential GDP growth, but a tight monetary policy stance by the RBI is restraining consumption and investment demand.” The central bank in April 2014 forecast 8 percent CPI by January 2015, but the actual reading was 5.2 percent. Similarly, in April 2015, it predicted CPI at 5.8 percent by March 2016, while it cooled to 4.83 percent and in early 2016 when it called for 5 percent CPI by March 2017, it was 3.89 percent. “Since 2014, when the oil prices fell, they have not really believed that this fall is sustainable, they keep expecting inflation to rise and rise,” she said.
Urjit Patel became RBI governor in September 2016, taking over from Raghuram Rajan. Goyal is also critical of the central bank’s belief that keeping interest rates high will curb inflationary expectations, which she says are guided more by the commodity and food prices. “Estimates have shown that oil prices, food prices affect inflationary expectations more than other things, more than high interest rates,” she said. “When you are on a secular downward trend for commodities, shale oil coming in and you have reforms kicking in agriculture, I mean the RBI should have strongly communicated this. I think, it would have helped anchor household inflation expectations.”