Hike rates

Forbes India – Inflation shock could push RBI to hike rates in June


Consumer Indrani Majumder buys vegetables from a roadside vegetable vendor in Kolkata, India, March 22, 2022. Picture taken March 22, 2022; Image: Rupak De Chowdhuri/REUTERS

BBarely three days after the monetary policy committee’s long-running decision to prioritize rising inflation over weak growth by gradually weaning the economy from ultra-accommodation, the economy suffered a double blow. First, the consumer price index jumped to 6.95% from 6.07% in February, well above economists’ and analysts’ estimate of 6.3-6.4%. Clearly, as the greatest economists have long feared, inflation is no longer transitory.Rising food prices mainly pushed up retail price inflation, suggesting that the pass-through from high commodity prices had begun. Core inflation (excluding food and fuel) also rose sharply by 60 basis points to 6.6%. Moreover, core rural inflation increased to 7.7% while core urban inflation stood at 5.7%. According to economists, underlying inflation should remain rigid and high over the coming months. In turn, price pressures are expected to continue to build in the coming weeks. Fuel prices, especially gasoline and diesel, rose 3-4% in April from the previous month. Edible oil and gold prices are slowly rising and will continue to weigh on retail inflation. “Adverse base effects in the case of other food items are expected to push headline CPI inflation to 7.3% in April,” Bank of America (BoFA) economists said in a report dated 2019. April 12. The brokerage sharply revised its estimate of CPI inflation. for the financial year 23 to 6% against 5.5% previously. This is higher than the RBI’s inflation forecast of 5.7%. A note from Kotak Mahindra Bank estimates average inflation at 6.2% in FY23. and in non-agricultural products, and continued supply chain disruptions are likely to continue to pose significant upside risks to inflation,” the report said.Until April, the central bank had stuck to its game plan of maintaining the weak signs of growth and had for so long refrained from changing its accommodative policy, despite the persistent rise in price levels, which crossed their upper threshold of 6% in January. and February.However, despite the Reserve Bank of India’s Monetary Policy Committee (MPC) keeping the repo rate at a historic low of 4% for 11 consecutive quarters, GDP growth has not picked up. significantly. Finally yielding, the central bank revised down its growth estimate for the current fiscal year to 7.2% from 7.8% earlier in its April policy.Second, industrial production in February was “disappointing” as it improved slightly to 1.7% from 1.5% in January, well below analysts’ and economists’ consensus forecast of 2.9-3, 3%. Manufacturing activity has been dismal for consecutive quarters.Today, supply disruptions and price shocks resulting from the Russian-Ukrainian war have made a difficult macroeconomic situation much more difficult. The level of uncertainty has increased and it is difficult to predict short-term economic outcomes.“In this context, a CPI inflation print of 7% and a likely situation where CPI inflation breaks through the 6% mark for three consecutive quarters would naturally make setting monetary policy more challenging in already uncertain times. We now see a much higher likelihood that the RBI MPC will increase the repo rate by 25 basis points in the upcoming June policy while turning neutral,” the BoFA report quoted earlier said.On April 8, the MPC voted unanimously to keep the benchmark repo rate at 4% and remain dovish. But with endorsements: the monetary policy stressed that the central bank “will remain accommodative while focusing on the withdrawal of accommodative measures to ensure that inflation remains within target in the future, while supporting growth” .In an effort to do so, without getting upset, the Standing Deposit Facility (SDF) rate was newly set as the floor of the Liquidity Adjustment Facility (LAF) corridor at 3.75%. With this decision, the reverse repo rate is now obsolete. But given that inflation unexpectedly hit 7% in March, is that too little too late?Sonal Varma, MD and Chief Economist, Nomura, says inflation expectations over the past two years have risen. “Our concern is that this will be the third year of high inflation that widens. even will become a negative (factor) for growth.Given the rise in world oil and commodity prices, it is not yet certain that inflation has peaked. Soaring input costs translated into higher production costs which were partly passed on to consumers, leading to higher prices in most categories of goods and services.“Inflation is a growing risk in India. The country has the highest inflation rate among major Asia-Pacific economies. It also seems to be generalized and in particular embedded in food prices. Additionally, given the rise in global energy prices since the Russian-Ukrainian military conflict, inflation could rise further in the coming months,” says Steve Cochrane, chief economist, APAC, Moody’s Analytics. Varma adds that the RBI needs to act on inflation as soon as possible so as not to end up hurting medium-term growth prospects or catching up on rate hikes later, as inflation is unlikely to cool down. to 4-5 percent in the next six to nine months. It pegs inflation at around 6.2% for the current calendar year.“If the Russian-Ukrainian conflict can come to a resolution by mid-year, then the risk premia now embedded in many commodities will decline, commodity prices will return closer to their baseline levels. ‘before the conflict, the risks of supply chain constraints will ease and economic growth could pick up again in the second half of this year,’ says Cochrane.Clearly, the investment cycle needs to restart to drive a sustainable recovery. Most manufacturing centers are not operating at full capacity utilization levels, so pent-up demand may not be sufficient to induce new investment for expansion.“A recovery in manufacturing and services would suggest that a release of pent-up demand could fuel the economic recovery. But the risk is that fears of inflation or a new wave of Covid will limit spending and the reintegration of the workforce into the labor force,” adds Cochrane.However, Varma says a sustainable recovery is a challenge. “It’s not stagflation (scenario), but it’s a stagflation-like effect of the current global macroeconomic backdrop and it means lower growth and higher inflation,” Varma adds.In the best-case scenario, the geopolitical conflict ends, inflation drops to 4-5% and growth takes off significantly over the next few months. But if the situation worsens and inflation exceeds 6%, investment and consumer demand remain weak and growth struggles, then the GDP outlook for the next two to three years will be weaker. .In the current situation, the concern is that the RBI may be behind the curve in rate hikes. “As a result, after six or nine months, the catch-up will not be ‘x’ but ‘4x’ of what we need to do, in which case the growth prospects for the next two to three years will be much lower,” says Varma.Given the high element of uncertainty, there are inherent risks that monetary action could go one way or the other. “The biggest short-term risk is the potential for policy error,” says Cochrane.As the RBI prepares to ensure, in its own words, a “soft landing” that is “at the right time”, Varma argues that it is better to act early to raise rates than to have to pivot more important on the line. “Ultimately, monetary policy has to do a cost-benefit analysis; how much are we incrementally supporting growth through our policies versus how much are we risking future growth due to higher inflation for so long,” she said.

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