MPC to reduce quantum of rate hike in August 2022

The June monetary policy review saw an increase of 50 basis points (bps) in the repo rate, following an off-cycle hike of 40 bps by the Monetary Policy Committee (MPC) in May. With commodity prices falling amid fears of a global slowdown, there is a ray of hope that India’s consumer price index (CPI) inflation will fall within the tolerance band of 2-6% of the MPC by the mid-September quarter. Despite an aggressive US Federal Reserve, we expect a modest rate hike of 60 bps from the MPC spread across two policy reviews, followed by a pause to assess the strength of growth. In June, the MPC sharply raised its CPI inflation forecast for fiscal year 2013 to 6.7%, with a broadly balanced risk appetite from 5.7% projected in April. Subsequent data showed that the CPI inflation reading dipped to 7.0% in May-June, from an alarming 7.8% in April, while well above the upper tolerance level of 6.0%. However, the average reading for the quarter, 7.3%, fell marginally behind the MPC’s forecast of 7.5%.

Subsequently, fears of an impending global recession led to a fall in commodity prices. We studied a trimmed version of the Bloomberg Commodity Index which is more meaningful for India. This suggests that commodity prices have fallen by an average of ~10% on a MOM basis in July, after increasing in each of the past six months.

Commodity prices may stabilize in the second quarter of FY13, but if the commodity prices continue to moderate, there may be a downside correction in the subsequent quarters. However, we remain alert to the impact of the uneven monsoon on food inflation and the strong demand for services on inflation for that category.

Overall, we anticipate the CPI inflation reading to fall below 6% for most of the months from November to March 2023. Therefore, we expect the MPC to lower its FY13 CPI inflation projections from 6.7% to 6.5%.

MPC had retained its growth forecast for real GDP for FY13 at 7.2%, in line with our estimate. It had pegged the quarterly growth for Q1 FY23 at 16.2% based on the low of COVID 2.0, 6.2% for Q2 FY23, and 4.1% for Q3 F23 and 4.0% for Q4 FY23.

We believe that the Gross Domestic Product (GDP) growth will be 12.5-13% below the Committee’s estimates for Q1 FY23, due to the impact of increased commodity prices on demand for commodities and producers’ margins and adverse heatwave Looking at the impact on wheat yield and, therefore, on agricultural GVA growth.

With strong services demand, and the recent correction in key commodity prices likely to ease margin pressure on India Inc., we expect GDP growth of 6.5-7.0% for Q2 of FY13. Our estimate will increase.

Additionally, we forecast GDP growth in the second half of FY13 at 5.0-5.5%, which is close to the expected rate of growth, despite a bleak outlook for exports. This is based on our view that private capital expenditure will be back-ended and the expenditure of the State Governments 1 trillion capex loans from the Indian government will increase post-monsoon, even though demand for services remains strong. Overall, while we expect the MPC to maintain its growth forecast at 7.2% in the August Policy Review, the quarterly estimates may be rebalanced in favor of a strong second half.

The US Fed recently hiked back-to-back 75 bps in July. Subsequently, Indian stock markets edged up, INR marginally appreciated, and the 10-year G-Sec yield declined. Looking ahead, in our view, the MPC is more likely to be affected from the standpoint of domestic-inflation growth dynamics than the size of the Fed’s actions.

We interpreted the rate hike from 40 bps in May to 50 bps in June as an attempt to lower inflation expectations. As Indian inflation is expected to peak, the size of the rate hike may shrink to 35-40 bps in August, from 20-25 bps expected in September.

Large forex sell-offs to contain volatility in the rupee have triggered a surprisingly sharp decline in systemic and durable liquidity surpluses, contrary to central bank guidance around gradual withdrawals. 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 rate corridor. Systemic liquidity is apparently turning neutral. To align with this, the MPC may announce a change in the monetary policy stance to neutral in the August or September reviews.

Aditi Nair is the Chief Economist of Icra Limited.

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