While the RBI unexpectedly handed the markets a sweet deal by holding rates, equity, bond and currency markets remained surprisingly displeased. The RBI’s narrow focus on inflation amid growing macro imbalances, and also its notable lowering of inflation projection for the second half of this fiscal, appears to have rattled the markets.
Against the RBI’s CPI inflation forecast of 3.9-4.5 per cent, we believe that the CPI inflation could move to about 5 per cent in the second half of FY19. This could prompt two rate hikes by the RBI in FY19. Importantly, as concerns over fiscal slippages, falling rupee and tightening of global liquidity take center stage, the RBI letting its guard down has not gone down well with the markets.
Inflation risks
CPI inflation fell to 3.7 per cent in August from 4.17 per cent in July. This was led by food inflation, driven by a sharp fall in vegetable prices. But the RBI’s move to lower its overall inflation estimate based on exceptionally soft vegetable or pulse prices, is not altogether a prudent move at this time as it is still unclear how vegetable inflation will move in the coming months.
That aside, the sharp rise in core inflation (excluding food and fuel) over the past year, remains a concern. While core inflation moderated in August from July levels, it still remains high at 5.9 per cent – up sharply from 4.5 per cent in August last year. The rise in global crude prices continues to rattle markets. This has led to fuel inflation moving up to 8.5 per cent in August from 7.96 per cent in July. Uncertainty over future price movements persist.
The RBI has also highlighted various factors impacting inflation – increase in minimum support prices (MSPs), surge in crude prices, volatile global markets and depreciating rupee. In view of this, the RBI lowering its inflation target after raising it in its last policy meet, appears unconvincing and too soon.
It is probably this, and the fact that the RBI has brushed aside wider concerns on growing macro imbalances – such as fiscal deficit or depreciating rupee – and placed more importance to near-term inflation trajectory, which appears to have rattled the markets.