We've said this before, and we have found new evidence since: India may have already become a 4% inflation economy. We use three different methodologies that carefully strip out the temporary noise around inflation to give us a sense of the underlying momentum and where inflation could go over the next few years. In each case we find it to be pegged at 4%, according to HSBC Global Research.
In our first method we find that the long-term inflation differential between India and the world is close to 2%, but it rose to over 5% in the 2008-2013 period. Many commentators assume the latter is normal, when in fact it was an abnormal episode in India's inflation history. However, the factors that caused it have reversed and India's inflation differential may well be getting back to the pre-2008 levels, suggesting domestic inflation could be under 4.5% over the next few years.
''The second method shows that inflation expectations have now fallen into a virtuous cycle and are likely to stay there, anchoring India's inflation rate at the 4% target,'' said Pranjul Bhandari, Chief India Economist, HSBC Global Research.
''In the third method, we try to find the new normal of food inflation. A confluence of one-off factors (a bumper crop, demonetization and GST implementation) and durable measures (food distribution reforms) have pushed it into negative territory. We shave off the temporary factors and quantify the impact of long-lasting food reforms to find that when the dust settles, we are likely to see food inflation resting at 4%.''
''So what does 4% inflation mean for rate cuts? If the RBI was a pure inflation targeter, it would mean no rate cuts (or hikes) since the target is perfectly met. If it was a real rates targeter and wanted to lower real rates to, say, 1.5% (where it was for much of the last two years), it could cut rates by about 75bps. But, in reality, the RBI is not a real rates targeter and has recently mentioned that its tolerance for slightly higher real rates is justified during periods of financial impairment.''
''As such we stick to our forecast at the lower end of the rate cut possibility range. We expect the RBI to cut the policy repo rate by 25bps on 2 August to bring it down to 6%. We see a risk of another 25bps rate cut if inflation remains well below 4% in 2HFY18.''
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