In its sixth bi-monthly monetary policy, the Reserve Bank of India (RBI) on Thursday revised the retail inflation forecast upward to 6.5 per cent for January-March quarter of the current fiscal.
The inflation level is projected to be 5.4-5.0% for the first half of FY21 and 3.2 per cent for Q3 of FY21 with risks broadly balanced.
The projected inflation is beyond the RBI's comfort level of 4 per cent with a margin of 2 per cent on either side thus reducing the scope of reduction in key policy rate in the short run.
The Monetary Policy Committee (MPC) observed that food inflation is likely to soften from the high levels of December and the decline is expected to become more pronounced during the last quarter of FY20 as onion prices fall rapidly in response to arrivals of late kharif and rabi harvests.
On the back of higher-than-expected food prices, December retail inflation had risen sharply to 7.35 per cent as against 5.54% in November 2019.
During the month of December, the prices of vegetables especially onions, pulses and fish were high. Though CPI inflation climbed high, core inflation which excludes food and fuel from computation remained subdued at 3.8%.
"Higher vegetables production, despite the early loss due to unseasonal rain, is also likely to have a salutary impact on food inflation. On the other hand, the recent pick-up in prices of non-vegetable food items, specifically in milk due to a rise in input costs, and in pulses due to a shortfall in kharif production, are all likely to sustain," the RBI said.
The central bank said that these factors could impart some upward bias to overall food prices. Further, crude prices are likely to remain volatile due to unabating geo-political tensions in the Middle East on the one hand, and the uncertain global economic outlook on the other.
The Monetary Policy Committee noted that there has been an increase in input costs for services, in recent months. However, subdued demand conditions, muted pricing power of corporates and the correction in energy prices since the last week of January may limit the pass-through to selling prices.
The six-member committee said that domestic financial markets remain volatile reflecting both global and domestic factors, which may have an influence on the inflation outlook. It further said that base effects would turn favourable during the third quarter of FY21.
"Taking into consideration these factors, and under the assumption of a normal south west monsoon in 2020-21, the CPI inflation projection is revised upwards to 6.5 per cent for Q4 of 2019-20, 5.4-5.0 per cent for the first half of FY21 and 3.2 per cent for Q3 of FY21 with risks broadly balanced," the RBI said.