Mumbai: Four years ago Indian inflation was running at more than 11%. Now it’s melted to a record low 2.2%, below Mexico, Turkey and the UK, as the central bank’s battle against price pressures gains traction.

The slide has prompted the Reserve Bank of India, led by Urjit Patel, to slash its inflation forecasts and led one member of its six-person monetary policy committee to break ranks at its 6 June announcement, stoking market speculation the bank could next cut rates, perhaps as early as August.

So what’s changed? Economists say cyclical or temporary issues like a stronger currency and weaker domestic demand, combined with structural factors such as better food management by Prime Minister Narendra Modi’s government are in play.

There are risks the cyclical factors could easily unwind, but for now, economists increasingly see structural factors winning out. Inflation is expected to hug the lower band of the RBI’s 2% to 3.5% forecast for the first half of the financial year ending in March and remain below the 3.5% to 4.5% target for the second half.

Becoming anchored

To be sure, India is benefiting from subdued inflation globally, especially in oil, the country’s biggest import. Along with a 5.4% rise in the rupee this year, the cost of imports have been held in check. Crucially, inflation expectations are becoming anchored.

“Inflation expectations, both backward and forward, have declined," said Pranjul Bhandari, chief India economist at HSBC Holdings. “Inflation each quarter is coming out to be lower than the previous quarter." One-year forward inflation forecasts have fallen steadily since 2014 with underlying inflation -- stripping out food, fuel, petrol and diesel -- in the 4 percent ballpark which the RBI targets in the medium term, she said.

Food prices

Radhika Rao, a Singapore-based economist at DBS Group, expects inflation to be below 2% for June, July and possibly August and only come within the 4% target by the March 2018 quarter. That will be nearly 100 basis points lower than the 5% estimate the RBI made in April.

Food prices have been a big reason for the decline. Vegetable prices declined nearly 20% last month from a year ago with potato prices, a key staple, contracting for the sixth straight month, the country’s wholesale price index last week showed. After averaging 11% between 2007 and 2013, food inflation has averaged 4.5% since the start of 2016.

Adroit management

The government’s cash ban in November led to “fire sales" by farmers as Rs500 and Rs1,000 notes were rendered useless overnight for purchases. More importantly, structural changes like better food management by the government and a muted rise in support prices for farmers have kept a lid on prices, economists say.

While falling food prices are good news for India’s rising middle-class, they haven’t gone down well with farmers, some of whom have taken to the streets to protest.

“We believe the backdrop continues to be that of adroit food management by the current government in terms of use of buffer stocks and the crackdown of hoarding, aided by softening in global food prices," said Prasanna Ananthasubramanian, Mumbai-based chief economist at ICICI Securities Primary Dealership Ltd.

Monsoons, which are critical to the water supply, are forecast to be normal for a second year running and are likely to exert downward pressure on food prices.

New base

Last month, India also moved to new base year to calculate wholesale prices, bringing it in line with the 2012 base year of the consumer price index. This will reduce volatility in wholesale prices and provide a clearer signal for the RBI, said Soumya Kanti Ghosh, group chief economic adviser at State Bank of India, the country’s largest bank.

Meanwhile, Bloomberg Intelligence economist Abhishek Gupta says that a raft of structural reforms, from the introduction of the goods and sales tax (GST) on 1 July, to easier foreign direct investment rules, should boost India’s growth potential over the longer term.

“At the same time, actual growth is lagging due to demonetization and high real interest rates," Gupta wrote in a report earlier this month. “The upshot -- a widening output gap that is pulling down inflation."

Wage increases for India’s government employees and farm-loan waivers could start to pressure inflation higher again, economists say. “Even if inflation bottoms out later this year, its recovery is likely to be modest," said DBS’s Rao. “Apart from inflation, lower financing costs will help investment growth." Bloomberg

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