Retail inflation based on the Consumer Price Index (CPI) slipped to a little over 7 per cent in May as against 7.79 per cent in April. Still, experts believe that policy interest rates will be hiked in August.

Two important factors played an important role in bringing down inflation in May from April’s eight-year high. The first was impact of duty revision on prices, and the second was a favourable base effect, as the rate of retail inflation in last May was 6.3 per cent. The month of May also saw a reduction in the prices of pulses, edible oils, and eggs, along with moderate inflation in the service sector.

However, there are two major risks to retail inflation — a rise in global crude prices and the depreciation of the rupee against the US dollar. Accordingly, it is estimated that inflation rate for the month of June could be around 7 per cent which is above the RBI’s tolerance level of 6 per cent. This means policy interest rate, better known as Repo Rate, to see more hikes.

Swati Arora, Economist with HDFC Bank, expects inflation to average at 7.2 per cent in H1 (April-September) of FY 23 and ease to 6.2-6.3 per cent in H2 FY23 assuming crude oil prices at $105 pbl in FY23. For the full current fiscal, she expects CPI to average at 6.7 per cent, with upside risks emanating from prolonged supply-side disruptions and depreciation in the rupee leading to higher imported inflation.

“The broad-based nature of the increase in inflation and the rising risks of the second-round impact on inflation expectations make a case for an aggressive monetary policy by the central bank going forward. We expect the RBI to raise policy rates by close to 5.75–6 per cent by the end of FY23,” Arora added.

Impact on economy

A note prepared by Sunil Kumar Sinha and Paras Jasrai of India Ratings and Research says the full impact of monetary tightening impacts the real economy with a lag of 6–9 months. On its part, the Centre announced an excise duty cut on petrol and diesel on May 22. Its impact on inflation will be felt much faster than the RBI’s rate cut, but will be visible only in June and thereafter both through direct and indirect channels.

Furthermore, it said that nevertheless, as prices of goods and services that once went up show downward rigidity, the second round of duty cuts on petrol and diesel will be somewhat muted.

Rajani Sinha, Chief Economist with Care Edge, expects CPI inflation to remain sharply above the RBI’s upper tolerance limit during the next few months owing to elevated crude and commodity prices. Also, with an expected improvement in the employment situation, there is a risk of a wage-price spiral setting in, which would make the task of reining in inflation even more difficult. In the second half of the fiscal, we could see some cooling of price pressures owing to control measures taken by the RBI and the government.

“Robust Kharif output helped by a conducive monsoon could ease food prices to a certain extent. A likely slowdown in the global economy will also limit the upside for inflation. Considering all these factors, we estimate CPI inflation to average around 6.5 per cent in FY23, with an upward bias,” Sinha said.

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