By Deepak Jasani
The RBI MPC in its upcoming August meeting could continue with frontloading of rate hikes to at least above its pre-covid level of 5.15% to keep a check on inflation. Elevated inflation prints have compelled central banks globally to speed-up monetary policy tightening to limit impact of high energy and food prices. The US Fed reserve in its July meeting raised rates by 75 bps to 2.25-2.5%, in line with its guidance and street expectations. The European Central Bank raised the key benchmark rate for the first time in 11 years by 50 bps. From its last policy meeting, the environment has changed – domestic inflation saw moderation, global market fear of recession has ebbed and the liquidity has tightened.
CPI inflation averages to 7.3% in Q1FY23, 20bps lower than RBI’s estimate.
Globally, high inflation has been a worrying factor. Both demand (owing to pandemic related fiscal stimulus and pent up demand) as well as supply factors are responsible for higher prices. In India, CPI inflation is mainly attributable to supply side factors whereas demand-led factors remain less influential. CPI inflation inched down marginally to 7.01% in June from 7.04% in May due to moderation in food inflation. This marked the sixth consecutive month that the CPI data has breached the RBI’s upper band of 6%. The latest print showed early signs of easing; it got some respite from the government’s reduction of excise duty on petrol and diesel. CPI inflation has averaged to 7.3% in Q1FY23 which is 20bps lower than the RBI’s estimate.
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RBI may want to anchor long-run inflation expectations
While the supply side measures taken by the government would undeniably alleviate some cost-push pressures, it needs to be complemented by calibrated monetary policy actions to anchor inflation expectations and contain the broadening price pressures. By frontloading rate hikes, the central bank may want to anchor long-run inflation expectations which would in turn deliver low and stable inflation over the medium term. Moreover, prices have been sticky in nature and till now the pass through of higher wholesale into CPI inflation is yet to be witnessed in a big way.
The wholesale price-based inflation has remained in double digits for 15 months and came at 15.18% in June. The wide wedge between WPI and CPI inflation suggests there is a risk of further passage of higher input costs from firms to consumers. However, cooling global commodity prices have come in as a breather for WPI.
Weakening rupee against US dollar poses threat of imported inflation
Easing of commodity prices on the back of global recessionary fears coupled with sharp correction in crude oil prices is likely to ease the domestic input cost pressures, providing some respite to the core-CPI print in the near term. But weakening of the rupee against the dollar poses a further threat of imported inflation. Monsoon and progress in Kharif sowing would be a key monitorable for food inflation trajectory. South-West monsoon has registered above normal rainfall at 8% (above LPA) till Jul 31, 2022; which bodes well for agriculture produce; however area under cultivation for paddy is still below last year. CPI inflation for Q2 is expected to undershoot the RBI’s target of 7.4%. For the full year, we expect inflation to average at 6.5%.
Tightening of financial conditions across the world amid elevated inflation on the backdrop on energy crisis in Europe is compounding recessionary fears. The Indian economy is better positioned compared to its emerging market peers with strong foreign exchange buffers and robust domestic-oriented growth drivers.
RBI to prevent further pressure on the Rupee
Apart from managing the growth-inflation dynamics; RBI would be mindful of the external sector imbalances too. Widening trade deficit with rupee remaining under pressure against the dollar (though better than its peers) due to global risk-off and elevated commodity prices warrants intervention mainly through managed FX intervention measures. While the rupee is well managed by RBI, interest rate differentials on nominal and real terms will have to be monitored and maintained by the RBI to prevent further pressure on the Rupee.
RBI to increase the policy rate by 50bps
Recent easing in commodity prices declines and relief commentary from Fed chair on the quantum of rate hike would provide some respite to policy makers. We expect both the growth and inflation forecasts to remain unchanged in this policy announcement. On the basis of expected normalisation of negative real rates and potential currency weakening, RBI will need to continue raising rates. We expect the RBI to increase the policy rate by 50bps in Aug meeting. To offset this hawkish move, it may tone down expectations of further rate hikes given the backdrop of falling inflation and relatively benign commentary by global central banks, though it will continue to watch data coming out from time to time.
(Deepak Jasani is the Head of Retail Research at HDFC Securities. The views expressed in the article are of the author and do not reflect the official position or policy of FinancialExpress.com.)