Retail Inflation Falls Below RBI’s Tolerance Band Igniting Rate Debate

India's retail inflation fell to a new low in June, adding to pressure on the Reserve Bank of India (RBI) to lower policy rates.

Consumer prices rose 1.53 percent in June, compared to last year, slower than the 2.18 percent increase seen in May, data from the Ministry of Statistics and Programme Implementation showed. Economists polled by Bloomberg had expected retail inflation at 1.68 percent.

At below 2 percent, inflation has now fallen below the lower bound of the RBI’s flexible inflation target of 4 percent (+/- 2 percent). It is also below the RBI’s forecast of 2-3.5 percent retail inflation in the first half of the financial year.

Most inflation risks are now on the downside, SBI said in a report following the announcement.

Inflation began sliding in March and took most, including the central bank, by surprise. The RBI, which has held the repo rate at 6.25 percent since October last year, acknowledged the falling inflation in its bi-monthly policy review in June by reducing its forecast for the current fiscal. Despite that, it held interest rates steady and did not change its neutral stance of monetary policy that it had adopted in March citing “sticky core inflation”. Most members of the monetary policy committee (MPC) still remain unconvinced that the fall in inflation is structural, minutes of the June meeting showed.

“This low [inflation] number and what it implies about underlying pricing pressures is something, I am sure, that all policymakers will reflect upon very very carefully,” India’s Chief Economic Adviser Arvind Subramanian told reporters. The number is reflective of a "paradigm shift in the inflation process to low levels of inflation,” he said.

Inflation Internals

Break-up of the inflation data shows that deflation in vegetables and pulses continues to bring down the headline number. In addition, core inflation categories have also seen a decline in price pressures.

• Vegetable prices declined 16.53 percent in June compared to 13.44 percent in May
• Vegetable price index, however, moved up between May and June
• Prices of pulses declined nearly 22 percent in June with the index level falling further as well
• Food and beverage inflation fell to -1.17 percent in June compared to -0.22 percent in May

• Housing inflation steadied further to 4.7 percent in June compared to 4.8 percent in May
• Inflation in clothing and footwear slowed to 4.1 percent compared to 4.4 percent in May
• Fuel and light inflation stood at 4.5 percent compared to 5.46 percent in May

The MPC will meet for the next policy review on August 1 and 2. The bond market has been factoring in the possibility of one last 25 basis point rate cut due to the fall in inflation. Ahead of the inflation data, India’s benchmark 10-year bond yield closed the Wednesday trading session at 6.46 percent.