RBI’s inflation projections scent a steady easing of the momentum of price changes: Bulletin

BL Mumbai Bureau | | Updated on: Aug 18, 2022

India is cautiously returning to be the flavour of this season’s portfolio flows

Inflation has edged down, but its persistence at elevated levels warrants appropriate policy responses to anchor expectations going forward, according to the Reserve Bank of India’s latest monthly bulletin.

The provisional data released by the National Statistical Office (NSO) on August 12, 2022 shows inflation, measured by year-on-year (y-o-y) changes in the all-India consumer price index (CPI), eased to 6.7 per cent in July from 7 per cent in the previous month

Heartening development

“Perhaps the most heartening development in recent times has been the easing of inflation in July 2022 by 30 basis points from June 2022 and an appreciable 60 basis points from the average of 7.3 per cent for Q1 (April-June):2022-23.

“This has validated our hypothesis that inflation peaked in April 2022. For the rest of the year, the RBI’s projections scent a steady easing of the momentum of price changes,” said 28 RBI senior and top RBI officials, including Deputy Governor MD Patra, in an article “State of the Economy”.

Ease in momentum

With the trajectory of outcomes largely in line with projections, the officials expect momentum of price changes to ease. The authors noted that if these expectations hold, inflation will fall from 7 to 5 per cent in Q1 next financial year - within the tolerance band, hovering closer to the target, but not yet positioned for landing. This is a decisive point in its trajectory.

“Imported inflation pressure points remain the overarching risk, followed by pending pass-through of input costs if producers regain pricing power, and wages. Yet, some risks have turned down – commodity prices, especially of crude; supply chain pressures; revving up of monsoon activity due to the depression in the Bay of Bengal,” the officials said.

The authors observed that after Q1-FY24, the task before the Monetary Policy Committee (MPC) would be to guide inflation to its target of 4 per cent. This may prove to be more arduous than the loss of height into the tolerance band, they added.

India, preferred destination

The RBI officials termed the return of capital flows to India after a hiatus, when the appetite of portfolio flows to Emerging Market Economies deteriorated as the US dollar appreciated breathlessly with the US Fed accelerating its hiking cycle, as a heartening development.

They underscored that India is becoming a preferred destination for portfolio flows – in August so far (until 12th), equity and debt segments recorded net inflow of US$ 4.4 billion and 0.3 billion, respectively.

“India is cautiously returning to be the flavour of this season’s portfolio flows…The market value of portfolio investments in India stood at US$ 623.8 billion on August 12, 2022.

“What is the outlook for these fickle flows? EMEs face the passive investor syndrome – exchange traded funds, index driven funds and such vehicles into which investors repose confidence in savvy fund managers out of the best business schools who are also the most sensitive to global spillovers,” as per the article.

The authors referred to IMF estimates that the response of passive portfolio flows to a one standard deviation shock to the interest rate has gone up six times now from that at the time of the taper tantrum.

“Tightening of global funding conditions as monetary policy is front loaded is hence expected to worsen the outlook for portfolio flows,” they said.

Need for active strategies

According to the IMF, interventions can lean against market illiquidity, and thus, play a role in muting excessive volatility.

“Capital outflow management measures should be a part of a broad policy package without avoiding macroeconomic adjustment wherever warranted. Debt management strategies are important for EMEs in view of their limited access to global financial markets,” opined the authors.

Hence, active strategies are called for in minimising market and rollover risks. Macro prudential policies can reduce the impact of shocks on market conditions and the economy.

The authors emphasised that India is poised to sustain a growth differential vis-a-vis the rest of the world on the basis of several fundamental factors: a demographic dividend; expansion in the availability of capital with increasing formalization of the economy and digital financial inclusion; the financialisation of savings as retail participation in capital markets grows; a sounder and fitter banking system with stronger balance sheets and a return to profitability.

Published on August 18, 2022
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