India’s headline inflation, measured by the Consumer Price Index (CPI), has not only trended down for five fiscals now, but also undershot the Reserve Bank of India (RBI)’s medium-term target of 4% for the second straight year in fiscal 2019. This has puzzled analysts and defied the RBI’s own projections.

So where does it go from here?

Our base-case scenario is headline inflation rising 60 basis points (bps) to 4% this fiscal from 3.4% in fiscal 2019. This calculus assumes food inflation rising to 3% from an abnormal low of 0.1%.

This is largely a 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 fall in 2019, as projected by the International Monetary Fund and World Bank.

In the context, we foresee two scenarios for fiscal 2020.

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

The downside scenario: If food inflation remains low for longer, the headline number could decline to 3.5%, while core inflation would soften because of the lagged impact of economic slack and restrained government spending.

A study of the main components of headline inflation and their trend over the past three decades leave us in no doubt that food has been the main retarding factor. Core inflation, which is supposed to be a better gauge of demand-side pressures in the economy, has been fairly sticky, irrespective of economic cycles. Fuel, on the other hand, has been the most volatile, but given its low weight in the CPI basket, its direct influence on headline inflation is limited.

And this is not the first time the Indian economy is witnessing low inflation. Between fiscals 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 witnessed normal monsoon, 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 a strong positive supply shock that additionally helped tamp food inflation.

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.

Finally, we conclude that 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.