A flurry of recent data, including rising CPI inflation, widening fiscal deficit and narrowing industrial production have led to expectations of a hike in interest rates. Economists expect the RBI to increase interest rates by 50 bps in FY19.
Radhika Rao, India Economist, DBS Bank, said in a report that upside risks to inflation and the need to maintain stability in the financial markets will keep monetary policy on a tightening bias. June inflation moved up to 5.0 per cent y-o-y versus 4.9 per cent in May, industrial production growth eased in May, and core inflation extended its climb past the RBI’s target band of 2-6 per cent for the second consecutive month, she noted.
Oil prices
Base effects and seasonal factors are likely to temper headline CPI readings in 2H FY19, but keep the full-year average above target. She expects a hike of 50 bps in FY19 with oil prices being the main wildcard.
Kotak Securities economists Upasana Bharadwaj and Suvodeep Rakshit said in a note to clients that core concerns continue for retail inflation. Although they believe CPI inflation has reached a peak at 5 per cent and will likely glide down to around 4.8 per cent by March 2019, the unfavourable base effects will dissipate over the next couple of months.
However, the domestic upside risks are likely to persist via sticky and high core inflation, extent of pass-through of MSP prices, and potential lower crop output, they said. They pointed out that the Index of Industrial Production slipped to 3.2 per cent in May after 4.8 per cent in April.
Manufacturing sector production grew 2.8 per cent, owing to a contraction in consumer non-durables (-2.6 per cent due to unfavourable base effect) even as capital goods’ growth remained steady at 7.6 per cent (likely contribution from CV production). Electricity sector increased to 4.2 per cent (2.1 per cent in April), while mining grew 5.7 per cent (4 per cent in April).
They expect headline and core inflation to average 4.6 per cent and 5.7 per cent, respectively, in FY2019.
They expect the RBI to remain cautious and possibly deliver another 25 bps rate hike in August, given the risks of (1) further broad-based increase in core inflation; (2) impact of MSP hikes; and (3) lower crop production, given the progress of monsoon and sowing pattern.
The recent data points related to monsoon and sowing indicate that rainfall has been subnormal until July 11 and acreage of kharif crops is 14.2 per cent below last year’s acreage for the same period as on July 6.
However, they added that the RBI may defer a hike to October, factoring in the agriculture impact as it awaits the government’s plan of implementing MSP benefits for non-procured crops and the pass-through of lower acreage into retail price formation.