September CPI at 7.41% | MPC likely to hike repo rate by at least 35 bps in December

A persistently higher inflation print in September builds the case for the Reserve Bank of India’s (RBI) rate-setting Monetary Policy Committee (MPC) to hike the repo rate by at least 35 basis points (bps) at its next policy meeting in December, economists told Moneycontrol on October 12.

Headline retail inflation measured by the Consumer Price Index (CPI) rose to 7.41 percent in September from 7.00 percent in August. At 7.41 percent, the September CPI inflation figure was slightly above the consensus estimate. As per a Moneycontrol poll, CPI inflation was seen rising to 7.3 percent.

Inflation has now completed three full years above the central bank’s medium-term target of 4 percent. More importantly, inflation has been outside the mandated 2-6 percent tolerance range for three consecutive quarters, which is the definition of failure under the flexible inflation targeting framework.

“Food inflation continued to play spoilsport, pushing up the headline inflation. Besides, higher services inflation and base effect were at play,” said Swati Arora, senior economist at HDFC Bank. “Going forward, we expect the headline inflation to remain above the RBI’s upper tolerance band of 6 percent until February 2023.”

Arora expects inflation to average at 6.7 percent for FY23, in line with the RBI’s estimate, with upside risks emanating from higher-than-expected food prices. On the policy front, she expects the MPC to deliver a 35 bps repo rate hike in December and another 25 bps in February.

Also read: IIP contracts 0.8% in August, worst performance in 18 months

Rate hike imminent 

As per the law, the RBI must now submit a report to the central government explaining why it failed to contain inflation, the remedial actions it proposes to take, and the time period within which inflation will return to target.

Economists said that upside risks to food inflation have grown with unseasonal rains hitting major crop producing states in October, with both harvest and sowing estimated to have taken a hit. That could keep overall inflation elevated, they added.

“Vegetable inflation too remains stubbornly high,” said Sonal Badhan, an economist at Bank of Baroda. “The full impact of this (unseasonal rains) on prices of cereals, pulses and vegetables is yet to be seen and risks are tilted to the upside.”

Core (non-fuel and food) inflation, which was at 6.1 percent in September as per Moneycontrol calculations, too is hardening, owing to a revival in demand, noted Badhan. Core inflation is unlikely to cool down anytime soon, with the onset of the festival season further supporting demand, she said.

According to Aditi Nayar, chief economist at ICRA, another rate hike is certain in the December policy meeting. The quantum of the next rate hike, however, will be determined by how much the inflation print recedes in October, as well as the strength of gross domestic product (GDP) growth for July-September.

The MPC has already hiked the repo rate—or the rate at which the RBI lends funds to banks—by 190 bps since April. The repo rate currently stands at 5.90 percent.

“The surge in prices of cereals, vegetables and pulses is continuing into October as well. The unseasonal rains are further expected to keep the food prices volatile,” said Upasna Bhardwaj, chief economist at Kotak Mahindra Bank. “We expect the RBI to hike the repo rate by 35-50 bps in the December policy, with the next move being more data-dependent.”

Also read: Bank lending rates set to rise further on expected RBI tightening, say experts

Money market implications

The rise in inflation and expected rate hikes will dampen bond market sentiment, money market experts said.

“Bond yields are expected to go up further when the market opens tomorrow. With the expectation of further hikes in MPC policy, bond yields will continue to go up. Besides, with tight liquidity conditions, we can expect 10-year bond yield to break the barrier of 7.50 percent now,” said Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincorp, a Mumbai-based debt advisory firm.

The rupee, on the other hand, is expected to trade in the range of 81.60 to 83.20 to the dollar in the near term, dealers said. The rupee closed at 82.35 against the dollar on October 12.

“I personally continue to expect another 50 bps rate hike by the MPC in the December policy,” said Kunal Sodhani, vice-president, the global trading centre, Shinhan Bank. “For USD/INR pair, I continue to expect a broader range of 81.60 to 83.20 to continue for some more time. All eyes now remain on US CPI data as the Fed (Federal Reserve) clearly states they remain data-dependent for future policies.”

Gaura Sen Gupta, India economist at IDFC First Bank, said that in case the Fed hikes policy rates by 75 bps in November, the RBI could hike the repo rate by 50 bps in December.

“We see the terminal repo rate between 6.50 and 6.75 percent, depending on the degree of hawkishness of the Fed,” she added.