What’s the Issue?
The Reserve Bank of India (RBI) is drawing criticism from economists after consistently overestimating inflation throughout 2025, leading to a tougher monetary policy than some argue was necessary.
A Brief Backdrop: Why the RBI Inflates Its Forecasts
RBI’s mandate is to maintain inflation around 4%, with a tolerance band. In 2023, it overhauled its model to Quarterly Projection Model 2.0, aiming to better factor in fiscal-monetary dynamics, fuel pricing, capital flows, and the impact of central bank actions.
Key Findings: Where the Model Went Wrong
- In the first quarter of 2025, the RBI’s inflation forecast overshot actual inflation by 0.7 percentage points its largest miss in nearly six years.
- Subsequent quarters saw smaller, but still significant, overestimations of 0.2 and 0.1 points.
- With October inflation surprisingly low (around 0.25%), the RBI’s projection of 2.6% for FY26 is being questioned by economists.
- UBS economist Tanvee Gupta Jain suggests a more realistic inflation rate of 2%–2.2%, far below RBI’s forecast.
Expert Insight: What Economists Are Saying
Sonal Varma of Nomura Holdings notes that central banks often embed policy intentions into their models. When inflation comes in below forecast repeatedly, she warns, “inflation-adjusted interest rates … become much higher than intended, and monetary policy becomes unintentionally restrictive.”
A. Prasanna, chief economist at ICICI Securities, believes food price volatility especially after a strong monsoon and supply chain gains is a major factor behind the model’s misfires.
Why This Matters: The Impact of Forecasting Errors
- Monetary Tightness: Overestimated inflation may force RBI to keep rates higher than necessary, stifling growth.
- Credibility Risk: Repeated errors could erode public trust in RBI’s economic guidance.
- Policy Distortion: Inflation projections inform interest rate decisions if they miss badly, policy could be misaligned with real economic conditions.
What’s Next for the RBI’s Forecasting Framework
- The RBI is reportedly refining its nowcasting and forecasting tools, incorporating more real-time data to improve accuracy.
- A major update to India’s consumer price index (CPI) basket is due soon, which could fix some of the bias arising from its outdated structure.
- Economists expect potential rate cuts if inflation stays subdued ICICI’s Prasanna projects a 25 basis-point cut as early as December.
Final Thoughts
The recent inflation misses are more than statistical errors they may reflect a model that doesn’t fully capture India’s changing economic landscape. As the RBI refines its forecasting tools, the stakes are high: better accuracy means better policy, more trust, and more efficient economic management.
