Oct 31, 2022 | Macro Economic

India Ratings and Research (Ind-Ra) believes the terminal policy rate will be 6.25% – 6.50% in the current rate hike cycle, subject to the retail inflation falling to 5.0-5.5% by 1QFY24. Although the Reserve Bank of India (RBI) has ruled out any such terminal policy rate, Ind-Ra believes a real policy rate of 1.0%-1.5% would provide comfort to the regulator as the real policy rate is in the negative territory.

The RBI in its Monetary Policy Statement of 30 September 2022 has projected the retail inflation to come in at 6.5% in 3QFY23, 5.8% in 4QFY23 and 5.0% in 1QFY24. Ind-Ra also expects the retail inflation to fall to 6.3% in 3QFY23 and 6.5% in 4QFY23 from 7.0% in 2QFY23. Ind-Ra therefore believes further rate hikes are likely to be in baby steps and will be more focused on restraining the broadening of price pressures and/or to pre-empt second round effects. In other words, it is likely to be less aggressive, more data dependent and focused on anchoring inflation/ inflationary expectation, as opposed to the rate hikes which started in May 2022, to essentially align the policy rate to surging inflation. In fact, despite the 190bp rate hike so far and tightening liquidity conditions, the RBI believes the monetary policy is still accommodative because the nominal policy repo rate if adjusted for inflation trails the 2019 levels even now.

A glance at the monthly data of retail inflation over the past five years indicates that it was mostly benign till October – November 2019 and has witnessed a spurt since December 2019. Retail inflation had remained elevated till November 2020, largely due to the supply-side disruptions caused by the COVID 19 related restrictions because demand-side pressures were absent during this period. Thereafter, it moderated and remained below the RBI’s upper tolerance band until December 2021 mainly due to the base effect, with the exception of May and June 2021. However, in January 2022 it again breached the upper tolerance band and since then has remained in excess of 6.0%.

The current phase (January 2022 – September 2022) of high retail inflation does not show any single or select group/categories/items predominantly contributing to it. In an ideal situation, each component is expected to contribute according to its weight to the retail inflation. A glance at the data shows that while food and miscellaneous categories were contributing broadly in line with their weights to the retail inflation during January – September 2022, the contribution of ‘clothing and footwear’ and ‘fuel and light’ was somewhat higher than their weights. The retail inflation thus appears to be more broad-based, with few pain points where negative/low inflation has tuned into middle single digit inflation, besides certain categories witnessing sustained high inflation.

These pain points were visible in the September 2022 retail inflation as food inflation reached a 22-month high and cereal inflation jumped to a 108-month high. The 2022 monsoon season ended with a rainfall surplus of 6%, but the sowing in case of paddy and pulses were down 5% and 4%, respectively. “Given the rise in wheat prices lately and below-par paddy sowing in the Gangetic plain, we believe cereals inflation will continue to exert pressure on retail inflation in addition to the sustained services sector and imported inflation. We also believe the emergence of headwinds from cereals to retail inflation is more worrisome as it tends to be stickier than the volatile food components such as fruits and vegetables”, says Dr. Sunil Kumar Sinha, Principal Economist and Senior Director Public Finance, Ind-Ra.