The government has gone wrong in getting its inflation prediction right many times in

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recent past. Indications are that its latest projection of inflation coming down to 7 per cent by March would go the same way.

A familiar pattern repeated itself as food inflation, according to data released on Thursday, climbed back to double-digit to touch 10.6 per cent. The government once again went wrong in inflation prediction.

In recent weeks, top government functionaries from the prime minister downwards, have been hopeful of a continued decline in food inflation. The climb-back of food inflation, therefore, comes as bit of a shock.

“I am worried that food inflation has reached double-digit figure,” said fina-nce minister Pranab Mukh-erjee on Friday. Mukherjee had earlier projected a steady decline.

“Food inflation for previous two weeks was perilously close to the double-digit mark. But it crossed that limit,” a disappointed Mukh-erjee said ahead of his meeting with the Reserve Bank of India governor D Subbarao.

RBI itself has been continuously chasing elusive all-commodities inflation targets for several months now. It is never able to hit the bull’s eye in so far as its inflation forecasts are concerned.

Not just RBI, other government functionaries and agencies — the prime minister, deputy chairman of the Planning Commission Montek Singh Ahuluwalia and PM’s economic advisory council headed by C Rangarajan — have all made inflation forecasts from time to time and have shot wide off the mark.

Now again there is a chorus of forecasts. The prime minister said on Wednesday that he expected inflation to start falling towards the year-end. Singh had made a similar prediction last year too, saying the overall wholesale price index (WPI) inflation would be down to 6 per cent by December 2010. But instead of coming down, it accelerated from December 2010.

This week at the economic editors conference here, the finance minister and the deputy chairman of the plan panel came up with their latest inflation forecasts.

“Inflation remained sticky around 9 per cent... I expect the overall WPI inflation to decline from December and I am hopeful that we will end the financial year with 7 per cent," Mukherjee said.

Ahluwalia agreed with both the prime minister and the finance minister that inflation would start declining from December, but he forecast that it would be at 8 per cent at the end of this financial year in March 2012.

Similarly, PMEAC, the think tank comprising top-notch economists that provides policy inputs at the highest level in the government, has a year-end inflation forecast of 7 per cent.

PMEAC chairman Rangarajan admitted on Friday that its inflation projections have gone wrong in the past and the latest indications such as food inflation inching up in fact militated against its year-end inflation forecast coming true. But regardless, he said, PMEAC would stick to its projections.

“Lately the high food inflation is due to increased demand for protein food such as eggs and meat. I still think inflation would come down to our projected level of around 7 per cent by March-end 2012. We will stick to our projections,” Rangarajan said.

Policy review

RBI, on its part, is scheduled to review its money policy on October 25, a day ahead of Diwali and it is widely expected to continue with its tight money policy, as inflation shows no signs of abating despite 12 interest rates hikes in the past 18 months. In the process, interest rates have gone up by 450 basis points.

In its last money policy review on September 16, RBI held on to its inflation forecast to 7 per cent at the end of 2011-12. In fact, RBI had in April forecast that 2011-12 would end with an inflation of only 6 per cent.

The central bank has repeatedly lost its bet on inflation in the last couple of years. In April 2010, RBI predicted that the March 2011 inflation would be 5.5 per cent. Even after three revisions — the last one was that the financial year 2010-11 would end with an inflation level of 8 per cent — it didn’t get its forecast right. The year actually ended with March 2011 inflation at 9.68 per cent, way above the RBI projection.

Why is it that the government does not seem to get the inflation numbers right — the actual inflation always gallops ahead of official projections? Economists, including the chief economic adviser in the finance ministry Kaushik Basu, have admitted that it is as hard to predict inflation in India as it is to predict the weather. This is because there are so many domestic and global economic uncertainties.

“There are many imponderables contributing to high inflation,” said chief economist of rating agency CARE Madan Sabnavis. Record farm production has coincided with hike in minimum support price (MSP) for crops. So higher production instead of bringing down prices has contributed partly to inflation, he explained.

Similarly, fuel prices have not come down and international commodity prices continue to remain firm, despite a global economic slowdown.

Sabnavis said international prices are beyond the control of the government. It may come down by March, but there are many factors that drive inflation, over which India has little control — global oil prices being one of them.

But under-prediction of inflation has its own shortcomings. It sends wrong message to the market, consumers and producers. For instance, each time RBI made a prediction, it took only a month or so for it to revise it higher and inflation got far ahead of the tools — the policy rate hikes — used to control it.

Head of treasury at IDBI Bank NS Venkatesh said, “There is a time lag in the flow of information which is resulting in the projections going wrong.” The government not only revises the inflation forecasts but also the actual inflation numbers, as the complete pass through of data does not happen on time.

Economists also point out that each time RBI has raised its policy rates in recent months, it has sought to do so to “anchor inflationary expectations”. But since official forecasts of inflation fall far short of actual inflation, they actually end up in raising expectations of even higher inflation among producers and consumers. Take for instance, the latest official forecast. It suggests that inflation would stay above at least 7 per cent till March 2012. That is a clear signal to consumers and producers that for next five months, inflation wouldn’t be less than 7 per cent and in fact, it could be much more than that going by past experience. When inflationary expectations are on the rise, anti-inflationary steps such as tightening of the money policy would be less effective.

WPI inflation, calculated year-on-year, for August was 9.78 per cent and for September was 9.72 per cent. What is then the logic of the prediction that it would start declining from December? One view is that official agencies seem to be banking on the high base effect in making this prediction. Inflation rates were high in corresponding months of last year.

The other factor, economists say, could be the seasonal impact. For example, in winter months, supply of fruits and vegetables improves and that could bring down their prices. But it didn’t work last year. Similarly, we have experienced no moderation of food prices this year even after a bountiful monsoon.

Unconventional logic

Inflation seems to have defied most conventional logic. This seems to be one reason why government never gets its inflation forecast right now-a-days. Take the case of the PMEAC. It has consistently gone wrong in its inflation forecasts. Why?

PMEAC chairman Rangarajan offered an explanation: “In 2009-10, the inflation projections went wrong because of the drought, which resulted in sharp fall in foodgrain output. This pushed up prices and the inflation forecast made on the basis of expectations of a good monsoon went awry. In 2010-11, inflation in general but particularly food inflation started coming down from April but unseasonal rains in November resulted in prices of vegetables going up by 64 per cent, reversing the falling food inflation. Usually prices of vegetables and onions fall during the winter because of seasonal factors resulting in sobering effect on inflation. That did not happen and this unexpected events led to inflation projections going wrong.”

The possibilities

What are the possibilities that the present predictions on inflation could come true?

Officials said the government is backing its forecast that inflation would be down to 7 per cent in March by anti-inflationary steps. The prime minister met top policy makers last week, seeking ways to curb inflation. In addition to the hawkish monetary stance of RBI, an inter-ministerial group is reviewing the overall inflation situation and is addressing possible steps to improve marketing and retailing, competition and supply chain improvements.

"We shall have to ensure that supply constraints, which are the major reason for the food inflation, are tackled," finance minister said on Friday.

Two views

There are as usual two views among economists outside the government over the possibility that inflation could actually come down to 7 per cent in March as predicted.

Sabnavis of CARE, for instance, believes that there is a strong demand in the economy and it is doubtful that the aggregate demand would be effectively contained even if RBI persists with the high interest rates regime. “Rate hikes have happened. But how do you reconcile a situation where credit has grown by 20 per cent, despite high interest rates and attempts to slowdown growth?” asked Sabnavis. Even if one assumes that the credit growth was on account of working capital, it means that production has not slowed down because demand continues to be high, he said.

At the same time, Icra’s senior economist Aditi Nayar would like to go along with the present official inflation forecast. Her logic stems from the fact that price indices declined or remained unchanged for six of the 11 sub-groups of non-food manufactured products in September 2011 on a month-on-month basis. This suggests that inflationary pressures have begun to moderate in certain sectors.

“Taking into account the base effect as well as the impact of the policy rate hikes undertaken by RBI, we expect the headline inflation rate to decline to around 6.8-7 per cent by March 2012 in line with the baseline projection made by RBI, unless commodity prices increase sharply in the coming months,” she said.

Nayar, however, qualifies this by pointing out that food inflation remained elevated in 2011-12 on account of various structural factors, including changing preferences, which have resulted in a demand-supply mismatch for certain items.

She also concedes that inflation related to non-vegetarian protein items remains high and prices of such items are likely to remain rigid, as an adequate supply response is unlikely in the short term. Prices of pulses are also expected to continue to rise, reflecting the lower area sown under pulses in 2011 compared with the previous year, which would also result in a higher import requirement. Inflation related to vegetables and fruit may remain volatile, on account of the perishable nature of these items. However, a substantial increase in area sown under rice in conjunction with the considerable available stocks of rice and wheat suggests that the inflation related to cereals is likely to remain moderate.

Others are not that sanguine. There are strong concerns that the government’s fiscal position is deteriorating as its spending more than it can afford. This could further fuel inflation and belie forecasts that it would come down to 7 per cent by the end of the financial year.

“The government cannot have a loose fiscal policy and RBI a tight monetary policy”, economic adviser to the Tatas Siddhartha Roy said. Both have to be in tandem. Both the government and RBI are making projections but the government expenditure should be curtailed and the supply bottlenecks should be removed for a composite policy action to be effective, he said.