Tail Risks of Inflation in India

This paper estimates the tail risks of consumer price inflation in India using a quantile regression framework. It examines the impact of various domestic and global macroeconomic factors, along with the role of inflation targeting (IT) in reducing the inflation tail risks as well as the shifts in its conditional distribution. A rise in domestic income and household inflation expectations increases the upside risk and lowers the downside risk to inflation. Elevated global commodity prices of - both fuel (i.e., crude oil) and non-fuel - raise the upside risks to inflation. Easy financial conditions also pose upside risks to CPI headline inflation. Furthermore, global economic growth has a strong positive influence on the upper tail risk of inflation. Results also show that both lower and upper tail risks of inflation have stabilized in the IT period. The paper concludes that these macroeconomic factors fairly capture the tail risks to the inflation target band of 2 to 6 per cent in India. While examining the response of the monetary policy to asymmetry and uncertainty of inflation distribution, the paper finds evidence of tightening of the monetary policy during periods of higher inflation uncertainty