MPC meet: RBI's retail inflation projection will decide interest rate hikes in coming months
In its monetary policy outcome tomorrow, the Reserve Bank of India is likely to revise its consumer price index (CPI) or retail inflation forecast from 5.7 per cent to 6.5 per cent plus for the current fiscal 2022-23.
- Jun 7, 2022,
- Updated Jun 7, 2022 6:33 PM IST
The Reserve Bank of India's (RBI) repo rate hike from 4.40 per cent in tomorrow's monetary policy is a no-brainer, but its inflation projection for the year is going to decide the quantum of interest rate hikes in the coming months. In April policy, the RBI was quite optimistic with a 4.5 per cent retail inflation or consumer price index (CPI) target for the year. But the Russia-Ukraine conflict changed the inflation trajectory for the worse. In its off-cycle meeting last month, the RBI hurriedly upped the inflation target to 5.7 per cent for 2022-23 and also hiked the repo rate by 40 basis points. Given the inflation numbers close to 8 per cent in April, the RBI is all set to revise its inflation forecast for the year. Let's take a look at the key moving parts of RBI’s inflation projection.
Govt has acted to tame inflation, but they have budget constraints
In early this month, the government finally acted by reducing the excise duties on petrol and diesel, which helped in containing the fuel prices at the retail pump stations. Some states have also pitched in by reducing the VAT duties, which comes under their domain. The current excise duty reductions are likely to result in a revenue loss of around Rs 1 lakh crore. Given the high fiscal deficit of 6.4 per cent in 2022-23 and the pressure on corporate tax collection especially after the rise in input costs, the government has limitations to accommodate further excise duties and other taxation relief.
Global crude oil prices continue to move up
The RBI's earlier inflation projection was based on moderate crude oil prices at around $100 per barrel. The current crude oil prices are hovering at $120 per barrel. The current level of crude prices will adversely impact the inflation path going forward.
Currency depreciation to further add to inflationary pressure
The domestic currency value against the US dollar is also coming under pressure because of outflow of dollars from India. The biggest worry is the trade as well as the current account deficit. Emkay Research has projected the current account deficit ( CAD) at 3 per cent of GDP in 2022-23.
“The terms of trade are likely to worsen overall. The effect of the oil price shock is likely to be exacerbated by the simultaneous rise in prices of coal, natural gas, edible oils, and gold (all of which account for around 40 per cent plus of the import basket),” states Emkay in its research report.
In addition, the recent ban on exports of wheat, sugar and iron will also impact the export numbers. The rate hikes by global central bankers are also pulling out foreign money from emerging markets including India, which is putting pressure on the rupee value. The RBI’s forex reserves, which are often used for protecting the volatility in rupee value, are also on the decline because of strengthening dollar and intervention ( dollar selling) by the central bank.
Global food prices are on the rise
The FAO Food Price Index (FFPI), which is a barometer of changes in the global food prices, is on an upward trajectory. Take for instance, the food price index which was less than 130 in 2021 and below 115 in 2020, has now shot up to 160 levels. In just a year, there has been a steep rise in the food index. In fact, the unilateral action by the countries is also impacting the prices. Moreover, the wheat export ban by India is also going to push up the global wheat prices. Similarly, restrictions imposed by other countries on exports is impacting the food prices.
Liquidity to support the growth but hurt by inflation
The primary objective of RBI's monetary policy is to maintain price stability (inflation control) while keeping in mind the objective of growth. RBI is in no mood to withdraw the surplus liquidity in the system. The current surplus liquidity in the system is around Rs 7-8 lakh crore. During the pre-COVID-19 period, the surplus liquidity was around Rs 2.5 lakh crore. It is unlikely that the RBI will bring down the liquidity levels to Rs 2 lakh crore in the near future. RBI Governor Das has recently said that the central bank will normalise surplus liquidity over a multi-year time cycle of 2 to 3 years. The idea is to support the nascent recovery in the economy. But this surplus liquidity is expected to influence the inflation trajectory in the upward direction.
The Reserve Bank of India's (RBI) repo rate hike from 4.40 per cent in tomorrow's monetary policy is a no-brainer, but its inflation projection for the year is going to decide the quantum of interest rate hikes in the coming months. In April policy, the RBI was quite optimistic with a 4.5 per cent retail inflation or consumer price index (CPI) target for the year. But the Russia-Ukraine conflict changed the inflation trajectory for the worse. In its off-cycle meeting last month, the RBI hurriedly upped the inflation target to 5.7 per cent for 2022-23 and also hiked the repo rate by 40 basis points. Given the inflation numbers close to 8 per cent in April, the RBI is all set to revise its inflation forecast for the year. Let's take a look at the key moving parts of RBI’s inflation projection.
Govt has acted to tame inflation, but they have budget constraints
In early this month, the government finally acted by reducing the excise duties on petrol and diesel, which helped in containing the fuel prices at the retail pump stations. Some states have also pitched in by reducing the VAT duties, which comes under their domain. The current excise duty reductions are likely to result in a revenue loss of around Rs 1 lakh crore. Given the high fiscal deficit of 6.4 per cent in 2022-23 and the pressure on corporate tax collection especially after the rise in input costs, the government has limitations to accommodate further excise duties and other taxation relief.
Global crude oil prices continue to move up
The RBI's earlier inflation projection was based on moderate crude oil prices at around $100 per barrel. The current crude oil prices are hovering at $120 per barrel. The current level of crude prices will adversely impact the inflation path going forward.
Currency depreciation to further add to inflationary pressure
The domestic currency value against the US dollar is also coming under pressure because of outflow of dollars from India. The biggest worry is the trade as well as the current account deficit. Emkay Research has projected the current account deficit ( CAD) at 3 per cent of GDP in 2022-23.
“The terms of trade are likely to worsen overall. The effect of the oil price shock is likely to be exacerbated by the simultaneous rise in prices of coal, natural gas, edible oils, and gold (all of which account for around 40 per cent plus of the import basket),” states Emkay in its research report.
In addition, the recent ban on exports of wheat, sugar and iron will also impact the export numbers. The rate hikes by global central bankers are also pulling out foreign money from emerging markets including India, which is putting pressure on the rupee value. The RBI’s forex reserves, which are often used for protecting the volatility in rupee value, are also on the decline because of strengthening dollar and intervention ( dollar selling) by the central bank.
Global food prices are on the rise
The FAO Food Price Index (FFPI), which is a barometer of changes in the global food prices, is on an upward trajectory. Take for instance, the food price index which was less than 130 in 2021 and below 115 in 2020, has now shot up to 160 levels. In just a year, there has been a steep rise in the food index. In fact, the unilateral action by the countries is also impacting the prices. Moreover, the wheat export ban by India is also going to push up the global wheat prices. Similarly, restrictions imposed by other countries on exports is impacting the food prices.
Liquidity to support the growth but hurt by inflation
The primary objective of RBI's monetary policy is to maintain price stability (inflation control) while keeping in mind the objective of growth. RBI is in no mood to withdraw the surplus liquidity in the system. The current surplus liquidity in the system is around Rs 7-8 lakh crore. During the pre-COVID-19 period, the surplus liquidity was around Rs 2.5 lakh crore. It is unlikely that the RBI will bring down the liquidity levels to Rs 2 lakh crore in the near future. RBI Governor Das has recently said that the central bank will normalise surplus liquidity over a multi-year time cycle of 2 to 3 years. The idea is to support the nascent recovery in the economy. But this surplus liquidity is expected to influence the inflation trajectory in the upward direction.