Businesses' inflation expectations dropped below 5% in July: IIM survey

The continued drop in inflation expectations will be welcomed by policymakers, with the RBI having raised the repo rate by 140 basis points in the last four months to battle soaring price levels

Inflation expectations of Indian businesses dropped below 5 percent in July, according to the Indian Institute of Management-Ahmedabad's (IIM-A) Business Inflation Expectations Survey (BIES).

As per the survey, released over the weekend, one-year ahead inflation expectations of Indian companies fell for the fourth consecutive month in July, coming in at 4.83 percent as against 5.17 percent in June.

The expectations were as high as 6.12 percent in March.

This the first time in 17 months that one-year ahead inflation expectations of Indian companies have fallen below 5 percent.

The continued drop in inflation expectations will likely be welcomed by policymakers, with the Reserve Bank of India (RBI) having raised the repo rate by 140 basis points to 5.4 percent in the last four months to battle soaring price levels.

On August 5, the central bank's Monetary Policy Committee (MPC) noted there was a risk of inflation expectations "destabilising" and triggering second round effects due to headline retail inflation staying above 6 percent. As such, the committee voted to raise the repo rate by 50 basis points at its meeting last month.

Anchoring inflation expectations is critical to ensuring price stability as they indicate where prices are expected to go in the future. As such, inflation expectations are a key input in the formulation of monetary policy.

It is, however, difficult to measure expectations, with the BIES being one of only two surveys conducted in India to measure inflation expectations, with the other being the RBI's Inflation Expectations Survey of Households.

Meanwhile, inflation outcomes have not been palatable and the RBI is on track to fail its inflation mandate.

While Consumer Price Index (CPI) inflation eased to a five-month low of 6.71 percent in July, it has spent seven straight months outside the RBI's 2-6 percent tolerance range. As such, the central bank is only two months away from failure, which is deemed to occur when average inflation is outside the 2-6 percent tolerance range for three consecutive quarters.

While failure looms for the RBI, the underlying inflation conditions seem to be improving.

"The cost perceptions data clearly indicates easing of cost pressures," the IIM-A survey found.

"Around 53 percent of the participating firms in the survey perceive significant (over 6 percent) cost increase, down significantly from 65 percent reported in the earlier round of the survey," it added.

Further, only 29 percent of firms now perceive their costs having increased by 6-10 percent. In June, 40 percent of firms felt costs were up 6-10 percent compared to last year.

The latest results of the BIES, which largely polls manufacturing companies, are based on the responses of around 1,100 companies. Most of the responses were received in the second half of August.