The Consumer Price Index-based (CPI) inflation that was declared for the month of June, after a two-month gap can put the Reserve Bank of India (RBI) in a sticky spot. As such, high inflation coupled with low interest rates, have led to negative real rates for some time now.

The June CPI inflation coming in at 6.09 per cent, higher than the RBI’s comfort zone (of 4 per cent), could the limit the central bank’s easing action in the upcoming August policy. Inflation has remained elevated over the past few months (even before the Covid-19-led lockdown) and it is expected to remain high in the coming months owing to supply disruptions and labour shortages.

Between December 2019 and February 2020, CPI was in the range of 6.6-7.35 per cent. The repo rate at 5.15 per cent, had implied 140-240 basis points (bps) negative real rates. With the repo rate falling to 4 per cent and CPI inflation moving up, negative real rates could persist for a longer time. This could not only put the RBI in a spot but also land savers, who are already grappling with decade-low interest rates on bank deposits and other popular fixed income options, in a pickle.

With inflation set to trend higher in the coming months, the RBI could hit the pause button in the upcoming August policy, after having cut the repo rate by 115 bps so far this year. But given the extraordinary demand destruction and underlying weak economic growth amid the pandemic crisis, the RBI is likely to continue its easing policy over the medium term. As such, weak bank credit growth, still high term spreads, and weak transmission of rate cuts, present a compelling case for the RBI to retain its easing stance.

Inflation concerns

Owing to non-availability of data within several sub-groups in the CPI basket, the NSO has used the imputation methodology to arrive at the CPI figures for April and May. According to the data published by the NSO, CPI inflation for April and May stood at 7.2 and 6.3 per cent respectively.

But according to the SBI report titled ‘Why NSO estimate of CPI is clearly understated’, the actual headline inflation could be much higher than the imputed inflation. The SBI report pegs June CPI inflation at 6.98 per cent, almost 90 bps higher than the NSO-estimated inflation. SBI’s April and May inflation estimates are also 150-250 bps higher than the NSO figure at 9.7 per cent and 7.8 per cent respectively.

While there could be notable revisions in the CPI inflation numbers going forward, the trend appears to be up, given the persisting supply disruptions.

But rather than focus on a single-point CPI inflation targeting, the RBI will have to reckon the inflation along with the changing narrative around growth and income levels. Given the immediate supply-side shocks, falling income levels, and weak bank balance sheets, the RBI will have to keep in mind the supply-driven inflation. As such, high inflation alongside low growth over the past few months (even before the lockdown) have highlighted the need for a review of the RBI’s inflation targeting pitch.

Negative real rates

With the RBI cutting its policy repo rate sharply over the past few months, banks have been slashing deposit rates.

Since this March, fixed deposit rates have fallen by 100-150 basis points across many banks, even higher in some cases.

Currently, public sector banks on an average offer 5.3-5.45 per cent on their three-five-year deposits. If the RBI cuts rates further, bank deposit rates will fall even more in the coming months. Persisting high inflation will only pinch savers more in the coming months.

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