BackMPC to temper rate hike quantum in August 2022
India’s CPI inflation may fall within MPC’s tolerance band of 2-6% by middle of Sep quarter
PremiumThe June monetary policy review had seen a stepped-up increase of 50 basis points (bps) in repo rate, following the Monetary Policy Committee’s (MPC’s) off-cycle hike of 40 bps in May. With commodity prices retreating amid fears of a global recession, there is a glimmer of hope that India’s consumer price index (CPI) inflation will fall within the MPC’s tolerance band of 2-6% by the middle of September quarter. Notwithstanding an aggressive US Federal Reserve, we foresee modest rate hikes of 60 bps from the MPC spread over two policy reviews, followed by a pause to assess the robustness of growth. In June, the MPC had sharply raised its CPI inflation forecast for FY23 to 6.7% with risks broadly balanced from the 5.7% projected in April. Subsequent data revealed that CPI inflation readings moderated to 7.0% each in May-June, from the alarming 7.8% in April, while remaining well above the upper tolerance level of 6.0%. However, the average reading for the quarter, of 7.3%, did end up mildly trailing the MPC’s forecast of 7.5%.
Subsequently, commodity prices receded on fears of a looming global recession. We studied a trimmed version of the Bloomberg Commodities Index that is more meaningful for India. It suggests that commodity prices have fallen by an average of ~10% on a MoM basis in July, after having risen in each of the last six months.
While there may be stickiness in the prices of goods in Q2 FY23, a downward correction may emerge in the subsequent quarter if the easing in commodity prices sustains. We do, however, remain watchful of the impact of an uneven monsoon on food inflation, and robust demand for services on the inflation for that category.
Overall, we project the CPI inflation readings to dip below 6% in a majority of the months from November to March 2023. Therefore, we expect the MPC to moderate the projections for FY23 CPI inflation from 6.7% to 6.5%.
The MPC had retained its growth forecast for real GDP for FY23 at 7.2%, in line with our projection. It had pegged the quarterly growth rates at 16.2% for Q1 FY23 on the low base of Covid 2.0, 6.2% for Q2 FY23, and a rather tepid 4.1% for Q3 F23 and 4.0% for Q4 FY23.
We believe gross domestic product (GDP) growth will be lower than the committee’s projections for Q1 FY23, at 12.5-13%, considering the impact of the elevated commodity prices on demand for goods and producers’ margins, and the adverse effect of the heatwave on wheat yields and, therefore, agri GVA growth.
With strong services demand, and the recent correction in key commodity prices likely to ease the pressure on margins of the India Inc., we expect an upside emerging to our estimate of the YoY GDP growth of 6.5-7.0% for Q2 FY23.
Additionally, we project GDP growth in H2 FY23 at 5.0-5.5%, inching close to the potential rate of growth, notwithstanding the bleak outlook for exports. This is based on our view that private capex will be back-ended and the state governments’ spending through the ₹1 trillion capex loan from the government of India will pick-up post monsoon, even as services demand remains robust. Overall, while we expect the MPC to maintain its growth forecast at 7.2% in the August policy review, the quarterly projections may be rebalanced in favour of a stronger second half.
The US Fed recently delivered a back-to-back hike of 75 bps in July . Subsequently, Indian stock markets rallied, the INR appreciated mildly, and 10-year G-sec yield dipped. Looking ahead, the MPC is more likely to be influenced by the outlook for domestic-inflation growth dynamics, than the size of the Fed’s actions, in our view.
We interpreted the step-up in the magnitude of the rate hike to 50 bps in June from 40 bps in May, as an attempt to clamp down on inflationary expectations. As Indian inflation is expected to have peaked, the size of rate hike in August is likely to taper down to 35-40 bps, leaving 20-25 bps expected increase in September.
Large forex sales to contain volatility in the rupee appear to have triggered a surprisingly rapid decline in systemic and durable liquidity surplus, contrary to the central bank’s guidance around a gradual withdrawal. With this, the weighted average call rate has exceeded the repo rate for the first time since April 2019, trading close to the MSF rate, which is the upper band of the policy rates corridor. Systemic liquidity is clearly shifting to neutral. To align with this, the MPC may announce a change in the monetary policy stance to neutral in either August or September reviews.
Aditi Nayar is chief economist, Icra Ltd.
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