Crisil Research expects headline inflation, measured by the Consumer Price Index (CPI), to rise 60 basis points (bps) to 4% this fiscal from 3.4% in fiscal 2019. This base case assumes food inflation rising to 3% from an abnormal low of 0.1%.

To be sure, this is largely statistical low-base effect at play. However, the rise in food prices may well remain subdued on a sequential basis for two reasons. One, the Indian Meteorological Department has suggested a well-distributed monsoon this year. Two, global food prices are expected to decline in 2019, as projected by the International Monetary Fund and World Bank.

The CPI-based gauge has now undershot the Reserve Bank of India (RBI)’s medium-term target of 4% for two straight fiscals, and the sharp decline in fiscal 2019 left analysts scratching their heads.

In a report titled Whither inflation? released today, Crisil proffers two inflation scenarios for this fiscal:

The upside scenario: If monsoon plays truant, especially in light of an El Niño event, food inflation could surge. Fuel inflation could follow suit if the current uptick in international crude prices persists. Also, core inflation (the part of headline inflation sans food and fuel) could strengthen further on account of the government’s consumption-oriented policies. Together, these could push headline inflation up to 5%.

The downside scenario: On the other hand, inflation could be lower at 3.5%. That would happen if the food inflation remains low for longer, core softens as a result of the lagged impact of economic slack, and government spending remains restrained.

“Our study of the main components of headline inflation and their trends over the past three decades confirms that food has been the main retarding factor,” said Dharmakirti Joshi, Chief Economist, Crisil Ltd. “Core inflation, which is supposed to be a better gauge of demand-side pressures in the economy, has been fairly sticky downwards, irrespective of economic cycles.”

Fuel, on the other hand, appears to be the most volatile, but given its low weight in the CPI basket, its direct influence on headline inflation is limited.

So how does all this fit in with India’s recently adopted inflation targeting framework?

So far, we note that inflation targeting has coincided with lower inflation and its volatility. Consumer inflation fell to 3.9% per year in three years after implementation of targeting, from an average 7.3% in the four years preceding. Its standard deviation fell to 1.2% from 2.4%.

“However, it is important to underscore the significant role of a sharp slowdown in food inflation – an idiosyncratic factor – in driving headline inflation lower. If the RBI’s medium-term target of 4% has to be met, that must sustain,” Joshi added.

The Whither inflation report says while household expectations of inflation have declined after the advent of the inflation targeting framework, their gap from actual inflation has become wider.

That, however, is not the case with the expectations of professional forecasters, who are better-informed. One-year ahead household inflation expectation is currently at 8.3%, compared with 4.2% for professional forecasters.

Also, this not the first time the Indian economy is witnessing prolonged spells of low inflation. Between fiscal 2000 and 2006, inflation averaged 3.9%, or below the RBI’s current medium-term target of 4%. Inflation in the current low phase (fiscals 2015 to 2019) has averaged 4.5%.

Both phases of low headline/food inflation saw normal monsoons (except for two sub-par years in each period), a relatively modest increase in minimum support prices, and benign global prices. However, what has been different in recent years, particularly in fiscals 2017 and 2018, is the strong, positive supply shock that has helped drive down food inflation.