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Low inflation may be short-lived as costly fuel and higher MSP set to bump up prices

Most experts believe that a rate hike of 25 basis points is imminent in the RBI’s next bi-monthly monetary policy meeting in October

September 20, 2018 / 04:43 PM IST

Cheaper food items and two successive interest rate hikes by the RBI may have cooled retail inflation to a 10-month low of 3.69 percent in August, but questions remained on how long the downward trend will continue.

Experts reckon that a persistent rise in fuel prices, a sharp slide in rupee that has made imports costlier and higher crop support prices could fan inflation, warranting another round of interest rate hike.

The government has announced a sharp hike in MSP for 14 summer-sown kharif crops. The higher MSP, the price at which the government buys crops from farmers, has been set at 1.5 times the cultivation cost, based on calculations made by the the Commission on Agricultural Costs and Prices.

MSP acts as a kind of guaranteed floor price, aimed to prevent distress sale by farmers. In the Budget for 2018-19, the government had first proposed to raise MSPs on a range of crops.

The higher MSPs will be applicable from October onward when the fresh kharif harvest start arriving in the markets, and experts believe that it will play out in the broader inflation rate in the later months.


CARE Ratings, a ratings agency and research firm, expects inflation to be in the range of 5-5.5 percent by the end of March, 2019.

“The high statistical base will help in terms of keeping the number (CPI) low for the next 2-3 months. The question is whether this will be sustained given that the MSPs will become effective in the coming months,” CARE Ratings said in note.

Similarly, according to  Aditi Nayar, principal economist of ICRA, a ratings firm, said the looming impact of revised MSPs, surge in crude oil prices and sharp weakening of the rupee would push up the inflation prints in the second of the financial year 2018-19.

“Headline CPI (consumer price index) inflation appears likely to range between 4.6-5.0 percent in January-March, 2018-19,” Nayar said last week.

The RBI and the government have set a retail inflation target of 4 percent for the next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.

Most experts also believe that a rate hike of 25 basis points(bps) is imminent in the Reserve Bank of India’s (RBI’s) next bi-monthly monetary policy meeting in October.

One basis point is one hundredth of a percentage point.

The central bank had hiked benchmark repo rates by 0.25 percentage points twice in its bi-monthly monetary policy meetings in June and August.

The RBI may also be goaded to increase interest rates to maintain India's attractiveness as a debt destination among foreign investors that will help get in more dollars into the local markets and contain the rupee's slide.

“Even though CPI inflation has cooled off, we believe October rate hike of 25 bps is imminent, but the question is whether the magnitude of rate hike could be even higher by 25 bps (say 50 bps),” Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India said.

While a currency crisis by logic calls for a bigger rate intervention, Ghosh said that given that since RBI is now an inflation targeting central bank, it will be really difficult to justify such action with inflation numbers continuing to be in 4-4.7 percent range through current fiscal, with the downside at sub 3.5% in November, 18.

Despite robust GDP growth and falling inflation, India is facing the threat of a widening twin deficit—current account and fiscal deficit—led by a clamour for an excise duty cut on fuel as falling value of rupee against dollar has made petrol diesel more expensive for the common man.

The rupee has fallen more than 12 percent this year, making it the worst performing Asian currency. Investors have been pulling out of emerging markets, betting on a stronger US economy.

Higher crude oil prices as well as concerns over an escalating global trade war triggered by the US and China’s retaliatory tariffs on goods imported from each other has had bearing on currencies across the world.
Shreya Nandi
first published: Sep 20, 2018 10:29 am

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