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India's Inflation: Is It Time For RBI To Keep Its Guard Down?

India's annual retail inflation in December 2022 declined from November and remained within the central bank's comfort zone as the rate of food price rises continued its downward trend

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"Stay the course", said economic experts at the annual summit of the World Economic Forum in Davos as they urged the central bankers to keep fighting inflation, despite signs of improvement. 

In the middle of the Ukraine war and the Covid-19 pandemic, economic experts noted that the signs of declining inflation, resilient consumer spending and strong labour markets, among others, suggested that growth could be rebounding in the short term.

"My message is that it is less bad than we feared a couple of months ago, but that doesn't quite get us to being good," said Kristalina Georgieva, Managing Director, International Monetary Fund (IMF) during a panel session on the global economic outlook. 

Amid the threat of rising inflation and interest rate increases from some central banks, several decision-makers have expressed determination to sustain rates, however, there is a risk that recent improvements could cause leaders to ease rates. 

In India, after several rate hikes by the Reserve Bank of India (RBI), the annual retail inflation in December 2022 declined from November and remained within the central bank's comfort zone as the rate of food price rises continued its downward trend. 

As per government data, the country's retail inflation decreased to 5.72 per cent in December on an annual basis as against 5.88 per cent in November 2022.

Aditi Nayar, Chief Economist, ICRA, said, "The consumer price index (CPI) inflation for January 2023 is likely to print at 5.8-6.0 per cent, slightly higher than the levels seen in December 2022, given the stickiness in core inflation and an unsupportive base for food inflation."

Nayar added that while the average CPI inflation in Q3 FY2023 (+6.1 per cent) has come in significantly below the MPC's projection of 6.6 per cent, we foresee a flattish print in Q4 FY2023, before a considerable correction sets in during Q1 FY2024. 

Taking into account the expected moderation in inflation to around 5.0 per cent in FY2024 from 6.6 per cent in FY2023 and an uneven domestic growth recovery amidst looming external headwinds, it is anticipated that the MPC may pause in its February 2023 meeting.

Regarding India's inflation, Prasenjit K Basu, Chief Economist, ICICI Securities said, "These are positive developments, although not a surprise to us. Base effects from high inflation a year ago, plus the moderation in food prices after a strong kharif harvest (with the exception of rice), were bound to moderate YoY CPI inflation in the Nov’22 to August 2023 period."

Those processes remain well intact, with the moderation in crude oil prices also helping to restrain CPI inflation. Basu said that they expect that headline CPI inflation will moderate to less than 5 per cent YoY in the April to June 2023 quarter.

Notably, economic experts at the annual summit of the WEF urged the central bankers to keep fighting inflation, despite signs of improvement. However, they were referring to inflation in the United States (US) and Eurozone as well as the United Kingdom (UK), which remain well above their 2 per cent year-on-year (YoY) inflation target (for core personal consumption expenditures-PCE inflation in the US, headline CPI inflation in the Eurozone). 

Core PCE inflation in the US was still 4.4 per cent YoY in December 2022, more than double the Fed’s inflation target (and the 15 consecutive months that core PCE inflation has been above 4 per cent YoY), while Eurozone CPI inflation was 9.2 per cent YoY, very far above its 2 per cent YoY target.

Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares and Stock Brokers, said, "The inflation problem is significantly less severe in the majority of emerging market nations, particularly those in Asia. Therefore, the advice for developing nations cannot be identical to that for developed nations. Already, countries like China and Turkey have adopted easy monetary policies. In the future, we anticipate greater divergence between the monetary policies of advanced and emerging market nations."

The big question—

At this point, one question is how much more evidence policymakers will need to see before they take their foot off the brake. Despite rapid monetary tightening and signs of demand softening, the labour markets in the majority of OECD countries remain remarkably robust. This is despite the loud announcements of layoffs made by some technology companies. If the monetary policy tightening is reversed prematurely, the low unemployment rates in OECD nations create apprehension about the possibility of a wage-price spiral. 

Hajra added that before pausing rate hikes, the central banks of OECD nations are likely to await early indicators of a weakening labour market. As inflation rates seem to have peaked in the majority of Western nations, monetary policy authorities are likely to make future rate hikes more sequenced. We, therefore, anticipate a period of gradual monetary tightening in these nations, followed by a pause in the second half of 2023.

However, unless the income growth rates begin to decelerate sharply, we do not foresee a reversal of the tightening measures occurring this year.

"The Fed, ECB and BoE need to continue to monitor their inflation rates (the UK’s inflation rate is 10.5 per cent YoY currently, very far above its 2 per cent target. By contrast, India has already succeeded in bringing CPI inflation inside its targeted range, and YoY inflation is set to moderate steadily further in January to March 2023, so the RBI need not raise its policy rate further," Basu mentioned. 

Meanwhile, the majority of emerging market nations are likely to experience a pause in monetary tightening in the near future. However, even in these nations, tightening is not expected to reverse this year. 

The next step of the RBI—

For India, the inflation target is 2-6 per cent YoY for the headline CPI inflation and it has been within the RBI’s targeted inflation rate for the past 2 months. Hence, experts noted that India's central bank does not need to do much more to fight inflation, as it is steadily moderating.

India deployed means other than monetary policy alone to fight inflation during the past year. Export duties were imposed on petroleum products, and iron and steel products to bolster the domestic supply of those products, and moderate their domestic prices. Having largely succeeded, the export duties are being gradually reduced/eliminated

"Given that CPI inflation was above 6 per cent YoY between January and October 2022, it was appropriate for the RBI to raise its policy rate from April to December 2022. 

"However, the high base from last year, coupled with lower global and local prices of food and energy, will enable the headline CPI inflation to moderate over the next few months without further increases in the policy repo rate," added Basu. 

Hajra also stated that the RBI would be on guard due to the high core inflation. As a result, we believe the RBI will refrain from both significant rate hikes and the early easing of monetary policy. If there is an unexpected rise in inflation, the stance will shift towards more hikes. 

"If growth decelerates more than anticipated, the stance will shift towards a rate cut. We believe that the path of least resistance for the RBI is to maintain the status quo, followed by a shift from a tightening to a neutral monetary policy stance by the end of 2023. Any rate reductions would not occur until at least 2024," he added.

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