RBI's policy normalisation will likely begin in 2H2021, but repo rate hikes should follow only in 2H2022
By Pranjul Bhandari & Aayushi Chaudhary
CPI inflation for June was close to our expectation (actual: 6.3% y-o-y, HSBC: 6.4%, BBG: 6.6%,). While the headline print was unchanged (also 6.3% in May), the sequential momentum dropped following a nasty spike last month. The fall was across the board, but starkest for core inflation (0% month-on-month sa, versus a 1.8% rise last month).
In terms of details, the momentum in core items such as recreation, personal care and household items dropped, likely led by a pay-back after last month’s spike, as well as the mending of supply chains as local lockdowns were gradually rolled back.
Having said that, despite falling, the quarterly momentum in health and transport costs remained elevated. The former likely reflecting pandemic-led stresses and the latter reflecting higher oil prices. Despite the fall, core inflation remains elevated at 5.8% y-o-y, and is likely to remain in the 5.5% ballpark for the rest of the year.
On the food front, despite the monthly sequential fall, the quarterly momentum remained elevated (7.9% quarter-on-quarter, sa, ann). Oils, sugar and prepared meals were most inflationary, even as the price momentum for cereals, pulses and milk came in softer, and even fell for expensive items like vegetable, fruits, egg, meat and fish. The food inflation outlook will depend a lot on monsoon rains. Reservoir levels, a key driver of food prices, are a shade lower than last year, and July rains will be important to fill them up. So far the first week of the month has witnessed weak rains, but the weather department forecasts a pick up over the next few weeks.
We forecast CPI inflation at 5.4% in FY22. The drivers of inflation will likely change, from logistical disruptions in 1H to cost push and services demand led inflation in 2H. Even as headline inflation falls over the next few months, driven by base effects, the headline print is likely to remain higher than the 4% target through the year. We expect the RBI to embark on a gradual normalisation path starting 4Q2021.
May’s Index of Industrial Production contracted sharply (by 10.9% month-on-month) after five months of expansion. Recall second wave peaked and lockdowns intensified in May. Even as the IP index came in 8% below the pre-pandemic levels (the seasonally adjusted index level in January 2020), the fall was c4 times lower than the fall during the first wave.
Production of consumer goods fell for the second consecutive month driven by contraction in both durable and non-durable goods. Durable goods production, a proxy for urban demand, came in 28% below pre-pandemic levels while non-durable good production, a proxy for rural demand, came in 7% below. This, we think, is a consequence of the second wave impacting urban affluent households more this time around. Capital goods production dipped to 23% below pre-pandemic levels, from just 5% below it last month. Surprisingly, ‘infrastructure and construction goods’ index continued to tread 3% above the pre-pandemic levels (though contracted month-on-month).
We expect GDP growth to move from an uncertainty-led contraction in 1H to a vaccination-led expansion in 2HFY22. Urban consumers may demand more services over the next few months, while rural consumers focus on goods. We forecast GDP to growth 8% in FY22, lower than consensus expectations of 9.3%.
With Priya Mehrishi, economics associate
Edited excerpts from HSBC
Global Research’s Data Reaction
report dated July 12
Bhandari is chief India economist & Chaudhary is economist, HSBC Securities and Capital Markets (India) Pvt Ltd