India’s inflation trends are heavily skewed on the upside and is expected to remain beyond the RBI’s threshold upper limit of 6% in the foreseeable future. The swiftly rising risks had prompted an off-cycle 40 basis point repo rate hike in early May with a clear guidance in terms of further frontloaded actions necessary to tame inflation. While the need to anchor inflationary expectations is real, I reckon that much of the elevated inflationary pressures are supply led, and hence there remains limited scope for MPC to manage it without choking demand.
Monetary tightness needs to be complemented with the supply-side fiscal interventions to ease price pressures. Appropriately, the government has taken wide ranging counter-cyclical measures lately to absorb the domestic price pressures. But that clearly puts further burden on India’s already weak public finance situation, limiting the ability to tackle any incremental demand or supply side shocks.
Inflation to affect consumer demand
Overall, I expect the MPC to revise the inflation trajectory upward by 70-80 basis points accounting for the recent upside price pressures. We estimate the headline FY2023 retail inflation reading at 6.4% (with average crude prices at $105/bbl), but given the persistence of supply side issues amid geopolitical conflicts, higher crude oil prices could risk retail inflation averaging around 7.3%. On the other hand, the formal economy continues to remain broadly resilient, although some fatigue has been witnessed lately.
I expect elevated inflation to weigh on consumer demand. The FY23 GDP growth will be around 7.3%, with a downward bias. Notably, much of the robust headline figure is coming on the back of a strong favourable effect expected in the first quarter of FY23, with rest of the quarters being fairly tepid.
From the policy withdrawal perspective, the RBI in the last two months has moved quite aggressively and swiftly. The weighted average overnight rates have risen by 80-90 basis points since the April MPC meeting. The recent supply side interventions by the government have clearly provided room for the MPC to avoid disruptive tightening. I expect a repo rate hike of 35-40 basis points in the upcoming June policy, with the repo rate likely around 5.5-5.75% by the end of the financial year 2022-23.
The war on inflation, though painful in the near term, could be shallower and shorter than expected, with a likely terminal rate around 6-6.25%. Furthermore, on the liquidity management front, I expect a CRR hike of additional 50 basis points, but given the recent sharp moderation in surplus, a likely action may be expected in August when the government spends begin to pick up.
(Upasna Bhardwaj is Chief Economist at Kotak Mahindra Bank.)