After the unexpected, off-cycle rate hike in May, further monetary tightening is clearly on the cards, with inflation taking precedence over growth concerns.

The Monetary Policy Committee (MPC) had unexpectedly raised the policy repo rate by 40 basis points (bps) in an off-cycle Monetary Policy meeting held on May 4. By advancing the rate decision by approximately one month as compared to the next scheduled meeting in June, the MPC had focussed on preventing inflationary expectations from un-anchoring in an increasingly uncertain environment.

Moreover, the MPC had raised the CRR by 50 bps to 4.50 per cent of the NDTL effective from May 21. Notwithstanding the rate hike, the Committee decided to remain accommodative while focussing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

In May, the MPC did not provide its revised growth and inflation forecasts for FY23. However, it highlighted that the inflation trajectory continues to be highly uncertain, which remains the case even now.

Since the May meeting, we have got the CPI inflation print for April, at a 95-month high 7.8 per cent, with an uncomfortable broad-basing of inflationary pressures. This was followed by a raft of measures from the government to ease prices, especially the cut in excise duties on petrol and diesel, as well as a ban on wheat exports, limitation on sugar exports, scrappage of Customs duties on the import of crude soyabean and sunflower oils for two years, and the imposition of an export duty on various finished steel products.

The forecast of the 2022 monsoon rainfall has been upgraded by the India Meteorological Department. However, a good monsoon may not be able to rapidly douse the prices of items such as wheat, which is a rabi crop.

Supply-side disruptions

Additionally, persistent supply-side disruptions owing to the geopolitical developments may impart stickiness to the food inflation trajectory during the period of the conflict, particularly for items such as edible oils.

The revived demand for services is likely to keep the core-inflation elevated in the coming months. Moreover, with the lockdowns easing in China, commodity price pressures have come to the fore yet again. These factors are likely to impart stickiness to the inflation trajectory going forward. The MPC may revise its estimate of the FY23 average CPI inflation to around 6.5 per cent, from its April projection of 5.7 per cent.

The other big data release was the GDP print for Q4 FY22, which revealed an expected moderation in the pace of growth to 4.1 per cent from 5.4 per cent in Q3 FY22. In particular, the growth of private final consumption expenditure declined sharply, which reflects both a high base and the impact of the third wave of Covid-19 in January-February. In contrast, government final consumption expenditure and gross fixed capital formation reported an encouraging pick-up. Overall, the slowdown in the GDP growth was less pronounced.

For FY22, India clocked a 22-year high GDP growth of 8.7 per cent, making it one of the fastest growing large economies in that year. On the back of this, we continue to expect real GDP to grow by 7.2 per cent in FY23, in line with the MPC’s April projections.

External demand

Despite the geopolitical headwinds, the available high frequency indicators for April-May are robust. However, there are concerns regarding elevated inflation levels constraining household budgets in the low-to-mid income segments, compression in business margins, and lower rabi output impacting rural farm sentiment.

As of now, we may not have the complete picture on the consumer side, as there is no timely indicator for consumer non-durables, the segment most likely to be squeezed by the inflationary concerns.

Moreover, external demand is set to weaken amidst the ongoing geopolitical tensions, elevated commodity prices, and policy tightening across advanced economies.

While early signs of a pick-up in private investments are visible, protracted geopolitical tensions and elevated commodity prices could impact corporate profits and dampen the investment climate. Consequently, government capex, especially by State governments, remains critical to support investment demand. We anticipate that the Central tax devolution to States will need to exceed the FY23 BE by ₹1.1 trillion. Accordingly, an early step up in the monthly devolution amount, may encourage them to boost their capital spending and support investment activity, amid the looming end of the GST compensation era.

At the same time, a recovery in demand for contact-intensive services and better income visibility for households dependent on the same will support the growth momentum, although the latter is likely to be uneven.

The measures taken by the government in the last month have distinctly lowered the probability of highly front-loaded rate hikes. We foresee the MPC hiking the repo rate by a further 40 bps in the June review and then by 35 bps each in the August and September reviews, taking the repo rate to 5.5 per cent. This is expected to be followed by a pause to assess the robustness of growth.

The writer is Chief Economist, ICRA Ltd