India inflation rate: Persistent above-target price rises give RBI little choice but to keep hiking borrowing costs

The inflation rate in India trended consistently above its central bank’s target range in the third quarter of 2022 despite falling from peak levels.

On 12 October, official data showed the India consumer price index (CPI) rose for the second straight month in September and came in slightly above market expectations.

The Reserve Bank of India (RBI) needs to control persistently-high inflation without impairing economic growth in one of the world’s fastest-growing economies.

Will the current inflation trend in India continue into 2023? Let’s look at what you need to know about the India inflation rate.

What is inflation?

Inflation is the increase in the price of goods and services over time. It is measured as the rate of change and expressed as a percentage.  

The consumer price index is the most widely used indicator of inflation. It measures the rate of change of the prices of goods and services used by households. 

CPI inflation is also known as headline inflation. Core CPI is an inflation index that excludes volatile measures such as food and energy.

In India, the national CPI index is calculated by the Ministry of Statistics & Programme Implementation (MOSPI) on a monthly basis. 

The RBI follows an inflation-targeting monetary policy with the aim of keeping inflation within its target range. 

India inflation rate history: Trending above RBI’s tolerance range

According to the RBI, the inflation target is set by the Government of India in consultation with the RBI once every five years.

The current inflation target in terms of the CPI index is set at 4%, with an upper tolerance band of 6% and a lower tolerance band of 2%.

India’s inflation rate in 2022 has trended above the RBI’s upper tolerance band of 6% in the year's first nine months.

At the start of the year, annual inflation rose 6.01% in January and 6.07% in February. The jump in commodities and food prices following the start of the Russia-Ukraine war pushed headline inflation to peak at 7.8% in April.

Inflation rates eased from peak levels, although increased domestic food prices due to lower crop production following heat waves and uneven rainfall have kept price pressures elevated.

After falling to 6.7% in July, headline inflation rose to 7% in August and 7.4% in September.

At 7.4%, September’s headline inflation figure was the highest since April’s peak. Food and beverage items were the main drivers of the increase in inflation in September.

Robert Carnell, Asia-Pacific regional head of research at Think, Netherlands-based ING Group’s research arm, called September’s provisional CPI numbers “nothing too alarming”.

“What this inflation release did not do, was suggest that Indian inflation is running out of control. The last four months of inflation increase on a sequential monthly basis, have been fairly steady at around 0.5-0.6%,” added Carnell.

Drivers of inflation in India: Rising commodities and food prices 

War in Ukraine has caused global commodity and energy supply shocks across the world, exacerbating post-pandemic supply chain problems.

In its bi-annual Monetary Policy Report, the RBI said the two primary drivers of inflation for India in 2022 have been the jump in commodities prices and domestic weather shocks.

Unsurprisingly, perishable items such as milk, vegetables, meat, and edible oils, and semi-perishable items, particularly petroleum products, medicines and cereals, have seen the highest cost increases in 2022.

The surge in crude oil prices to over $120 a barrel in the first half of 2022 was particularly hard on energy-importing nations such as India. The nation imports over 80% of its crude. According to the International Trade Administration, India is the world’s third-largest consumer of crude oil. 

“Brent crude prices remain at elevated levels, given the tight demand-supply balance, despite recent correction. Global food prices have declined by 14 per cent from an all-time high in March but are ruling 8 per cent over last year’s level,” said the RBI in its report.

The Indian rupee (INR) depreciation against the US dollar (USD) in 2022 added further price pressures due to higher import costs. As of 13 October 2022, the USD/INR exchange rate had risen over 10% year-to-date (YTD).

On the agriculture front, wheat prices in India have seen a sharp rise since March due to lower production following heat waves. In May, the government was forced to impose wheat export bans in order to prioritise domestic needs.

Rice prices have followed a similar trend due to increased demand spurred by the substitution of wheat for rice. Furthermore, the uneven distribution of monsoon rains in India has led to lower paddy and pulses sown in 2022 compared to a year ago.

Bank of America (BofA) Global Research in a note on 13 October 2022:

ING Group's Carnell noted: “Saying that food prices were the main driver for the increase in the September inflation rate is true, but it is also not very interesting given the fact that food accounts for around 45% of the Indian CPI basket by weight. In any given month, food will almost certainly be either the main reason Indian inflation rose or the reason that it fell.” 

India inflation rate forecast

In its India inflation forecast, the RBI projected the all-India CPI inflation rate to average 6.7% in the financial year 2022-2023 – above the central bank’s upper tolerance band of 6%.

The RBI expected headline inflation to trend at 7.2% in the quarter that ended September 2022, then falling to an average of 6.5% in the quarter that ended December 2022.

RBI’s India inflation projections expected headline inflation to come in within its tolerance band at 5.8% in the quarter that ended March 2023.

ING’s Think reiterated the Indian central bank’s view in a 12 October note:

The RBI noted its inflation expectations for the financial year 2023-2024 in its bi-annual report:

Further down the line, an RBI survey of professional forecasters revealed that five-year ahead inflation expectations rose by 10 basis points in September 2022 to 5%, while 10-year inflation expectations remained steady at 4.5%.

According to the RBI, the upside risks to the aforementioned India inflation rate forecast are geopolitical conflicts, elevated crude and commodity prices, high global financial market volatility due to aggressive monetary policy actions, prolonged supply chain disruptions, a shortfall in monsoon crop production, unseasonal rainfall and higher pass-through of input cost pressures to output prices due to increased demand.

What about interest rate forecasts for the near term? On 30 September, India’s Monetary Policy Committee voiced its intention to “remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward”. That came after a 50 basis point rate hike – its fourth since May 2022.

“Policy rates have probably not peaked yet, but they can be raised at a slower pace, and we look for only a 25bp hike at the next policy-setting meeting in December. That will take the repo rate to 6.15%, and we think that at that point, the RBI may be done,” noted Carnell.

Note that Indian inflation rate forecasts and India interest rate outlook from analysts and experts can be wrong. Forecasts shouldn’t be used as a substitute for your own research. Always conduct your own due diligence. Remember that your decision to trade or invest should depend on your risk tolerance, expertise in the market, portfolio size, and goals. And never trade money that you cannot afford to lose.

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