Drop in October inflation unlikely to deter RBI from hiking rates, say economists

The drop in inflation in October is unlikely to change the interest-rate hike course of the Reserve Bank of India's monetary policy committee (MPC) in the current financial year, economists said.

Retail inflation as measured by the Consumer Price Index (CPI) fell to 6.77 percent in October, the lowest in three months, from 7.41 percent in September.

Economists attributed the fall primarily to a favourable base effect. The print was broadly in-line with a Moneycontrol poll of 16 economists that estimated inflation to slide to 6.7 percent.

Despite the drop, inflation still remains above the RBI’s mandated 2-6 percent tolerance band. October marks the fourth year that inflation has stayed above 4 percent. It is also the 1oth straight month of inflation staying above the central bank's upper tolerance band of 6 percent.

“In line with our expectations, October’s CPI print has softened and we expect it to moderate further in the coming months as well on account of base effect and declining international commodity prices,” said Sonal Badhan, an economist at Bank of Baroda.

Food prices, however, will have to be closely watched, in particular those of vegetables, cereals and pulses, due to unseasonal domestic rains and rising international food prices, she added.

Badhan expects a 35 basis points (bps) repo rate hike when the MPC's meets from December 5-7, from the current 5.9 percent. The terminal repo rate will be at 6.5 percent by March, she added.

One basis point equals one-hundredth of a percentage point.

The RBI and the MPC have been tightening monetary policy for more than half a year now to quell soaring prices.

The policy repo rate—the rate at which the RBI lends funds to banks—has also been hiked by the MPC by 190 basis points during the period.

On November 3, the MPC met to discuss the report the central bank must submit to the government after three consecutive quarters of failing to meet the inflation mandate.

Rate hike imminent

Economists expect inflation to stay above the central bank’s target of 6 percent for FY23. The RBI projects inflation to average at 6.7 percent in FY23.

It expects inflation to average at 6.5 percent in October-December and fall to 5.8 percent in January-March before moderating to 5 percent in April-June next year.

Despite October’s inflation coming on expected lines, sequential price momentum continued. On a month-on-month basis, retail inflation continued to rise by 0.8 percent in October from 0.6 percent rise in September.

As Moneycontrol calculations show, core inflation, or inflation minus the volatile food and fuel items, was also sticky at 6 percent in October from 6.1 percent in September.

According to Swati Arora, economist at HDFC Bank, with inflation staying above the RBI’s upper tolerance band, and sticky, elevated core inflation are likely to sway the central bank to deliver more rate hikes.

Other economists agreed. “Since the pandemic core CPI inflation has remained elevated, reflecting the impact of supply-side disruptions,” said Gaura Sen Gupta, India economist at IDFC First Bank.

“Looking ahead we expect core inflation to remain high, averaging at 6 percent in the remainder of FY23, with services inflation expected to remain sticky, as consumption patterns normalise, shifting from goods to services.”

Gupta expects the RBI to hike repo rate by 50 bps in December and peak at 6.75 percent by February 2023.

Also read: WPI inflation falls to 19-month low of 8.39% in October on favourable base

‘RBI unlikely to match Fed’s pace’

The MPC, however, is unlikely to match the pace of rate hikes by the US Federal Reserve given inflation in India is largely supply-driven, economists said.

The Fed is expected to raise rates by 50 bps in December to continue taming price pressures. In the last four meetings, the Fed had raised rates by 75 bps each.

“We don’t expect the RBI to match the Fed in the pace of rate hikes, as inflation in India remains largely supply-side driven and labour market isn’t as tight as the US,” said Gupta.

Money market implications

The expected inflation print is unlikely to have an impact on the bond market, money market experts and dealers said.

A bond market dealer at a private bank said any sharp reaction in the bond market would only be warranted if the print would have been below 6.50 percent.

“Not much of a reaction is expected in the bond market due to this data,” said Kunal Sodhani, vice president-global trading center at Shinhan Bank. “However, the good part is inflation in the food basket came in at 7.01 percent in October as against 8.6 percent in September.”

Sodhani expects the RBI to raise the repo rate by 50 bps in December.

As far as the rupee is concerned, the momentum will be guided more by global developments, commentary from Fed officials and risk sentiment, experts said.

“There are about 15 Fed speakers scheduled to speak in this week and any hawkish tone could change the downward direction of the dollar,” said Anil Bhansali, head of treasury at Finrex Treasury Advisors. “I am expecting the rupee to be in the range of 80.50 to 82 this week.”