Over the last few months, inflation surged globally on the back of rising crude oil and other commodity costs, supply-side constraints and the Ukraine-Russia conflict which has driven up prices of edible oil and food grains. India’s Consumer Price Index (CPI) inflation, easing to 7.04 per cent in May from 7.79 per cent in April, should offer a breather but only temporarily, says economists.
The Reserve Bank of India is mandated to control retail inflation at 4 per cent, within a band of 2-6 per cent. At 7.04 per cent, CPI inflation is still over a per cent above the upper-end of the tolerance band. It has remained above the upper-end for five consecutive months now. Economists say inflation may continue to remain high in the coming months, with crude oil prices still elevated and no sign yet of the Russia-Ukraine conflict ending.
As such, RBI has forecast inflation to stay above 6 per cent in the first three quarters of the current financial year.
Worth noting is that CPI inflation moderation in May was driven by a favourable base effect and cut in duties on fuel by the government among other things. Sonal Varma, chief economist, India and Asia, ex-Japan at Nomura Securities points out inflation still remains broad-based with nearly 70 per cent of CPI sub-components rising above RBI’s mid-point target of 4 per cent.
So, in spite of some respite in May, inflation worries clearly may not be over yet.
“We do not believe inflation has peaked, owing to price pressures on food and energy and evidence of larger pass-through to consumers remaining. We expect CPI inflation to breach 8 per cent in July-September and average 7.5 per cent year-on-year in FY23, higher than RBI’s recently upgraded forecast of 6.7 per cent,” said Varma.
Dhananjay Sinha, MD and head – strategist at JM Financial Institutional Securities said the inflation outlook remains concerning given that it remains elevated even as aggregate demand recovery remains incomplete.
“Rising in pass-through of elevated input cost will likely keep retail inflation higher than RBI’s upper limit of 6 per cent. While RBI has scaled up its inflation target for FY23 to 6.7 per cent, a full 200 basis points higher than the initial projection six months back, there is still some upside given the context of higher crude oil prices and rupee depreciation,” said Sinha.
While inflation at 7.8 per cent in April was perhaps the peak, Sinha still sees it averaging at 7 per cent over the remainder of the current financial year.
Kotak Mahindra Bank economists Upasna Bhardwaj and Suvodeep Rakshit also believe that inflation may have peaked in April. But they also feel the descent will be slower and at least till November, inflation is likely to remain above 6 per cent.
“Upside risks to inflation remain from persistence of geopolitical tensions, direct and indirect impact of elevated global commodity prices, especially crude oil prices, and risks of further pass-through to domestic pump prices despite recent excise duty cuts, and rising raw material prices along with a weakening rupee,” the analysts say.
The Reserve Bank has already raised the policy repo rate by 90 basis points over the past two months. It surprised with a 40 bps rate hike in an out-of-turn monetary policy committee meeting in May and followed that up with a 50 bps hike earlier this month. Economists believe that despite the hikes, the RBI has a lot of catch-up to do. Therefore there will be further rate hikes in the MPC meets in August as well as October and perhaps even later.
“Although inflation moderated slightly in May, the real repo rate is deeply negative at -2.14 per cent (4.9 per cent - headline CPI at 7.04 per cent) and -1.3 per cent, given core inflation of 6.2 per cent. Thus, to arrive at a neutral real rate of 1 per cent, RBI will have to substantially increase the repo rate and tighten liquidity,” said Sinha of JM Financial.
Along with liquidity moderation, he expects RBI raising policy repo rate by another 100-150 bps, to 6.0-6.5 per cent.
Nomura’s Varma also sees repo rate touching 6.25 per cent by April 2023, with a 35 bps rate hike in August, followed by 25 bps hikes in subsequent MPC meetings in October, December, February and April. Varma also expects the cash reverse ratio to be raised by 100 bps this year.
“We continue to believe that upside surprises on inflation may (continue to) force the RBI’s hand into more tightening. We do not anticipate any pause in the policy rate at its pre-pandemic level (5.15 per cent),” she said.
The Kotak economists are also expecting further rate hikes, but their estimates are less aggressive. They have pencilled in a repo rate hike of 85 bps by March 2023, including 35 bps hike in August. They also expect CRR to be raised by 50 bps this year.