The government expects retail inflation to ease to 4.5-5 per cent in 2016-17 fiscal mainly due to continued downward pressure on global commodity prices and prospects of a normal monsoon.
The Economic Survey 2015-16 presented in Parliament today said another year of below potential growth will mean widening of output gap resulting into additional downward pressure on underlying inflation, which has already fallen below 5 per cent.
Meanwhile, if the monsoon returns to normal, food prices will ease, as the government remains committed to disciplined increase in minimum support prices for cereals and the rural wage growth remains muted, it said.
"For all these reasons, we project that Consumer Price Index (CPI) inflation will ease to between 4.5-5 per cent in 2016-17. We therefore think that the effective stance of monetary policy could be relaxed", said the Survey document tabled by Finance Minister Arun Jaitley in Parliament.
Government has projected the economy to expand by 7-7.75 per cent in 2016-17 against 7.6 per cent projected for current fiscal. It pegs the long-term potential at 8-10 per cent if exports grow rapidly.
The Reserve Bank, which had set a retail inflation target of around 6 per cent by January 2016, expects the rate of price rise to be around 5 per cent by the end of 2016-17 financial year.
In January, retail inflation was at 5.69 per cent, the highest in last 16 months.
The Survey expects that further price pressure relief should come from abroad.
"Oil prices have plunged in the first two months of 2016, as have some commodity prices, suggesting that input prices are likely to be lower next fiscal year.
"Beyond this factor lie other deflationary forces. As growth in China continues to slow, excess capacity there could continue to increase, which will put further downward pressure on the prices of tradable goods all around the world", it said.
It suggests oil prices to average to USD 35 per barrel next fiscal year compared with USD 45 per barrel in 2015-16.
However, the Survey said the part of this might be off-set by upward pressure coming from a depreciation of the rupee, especially if the US Federal Reserve Bank continues to raise interest rates, prompting capital flows to the US, although the prospects of aggressive Fed action are receding.
All this suggests that the RBI should be able to meet its target of 5 per cent (retail or CPI inflation) by March 2017, it said.
Global commodity prices such as crude oil, metals and cereals continued to decline across the globe in 2015-16, notwithstanding a few short spells of rebound.