RBI MPC preview: Das and Co may hike repo rate by 25-50 bps in August

If the inflation remains above 6% on average for the next three months, the RBI will have to explain to the govt in writing the reasons for its failure to keep the rate of price rise in check

While global commodity prices are falling on fears of a recession in the advanced world that may dampen the retail price inflation, part of it is likely to be negated by the impact of a depreciating rupee against the dollar. On the other hand, growth impulses on at least the industrial production front are still fragile.

For instance, Brent crude fell below $100 a barrel earlier this month but again rose over $100 later. Its futures for September fell for the fourth consecutive day to $102.72 a barrel on early Monday. The prices fell on worries that the Federal Reserve will raise interest rates at its meeting later Wednesday which will pull down demand.

However, the Indian basket of oil stood at $103.09 a barrel on Monday. The average price of the Indian basket of oil fell to $105.26 a barrel in July till Monday against $116.01 in the previous month.

Meanwhile, the rupee depreciated further from 78.01 against the dollar on average in June to 79.49 on average in July till the 25th.  

The net result may still lead to some easing of the consumer price index (CPI)-based inflation rate, which moderated to 7.01 per cent in June from 7.04 per cent in May. It should be noted that CPI inflation remained over the upper tolerance limit of six per cent mandated for the Reserve Bank of India's (RBI) monetary policy committee (MPC) for the sixth month in a row now.

Vivek Kumar, economist at QuantEco Research, said the correction in the global commodity prices since the early part of June this year has also coincided with a depreciating rupee. "While inflation sensitivity is relatively higher for the exchange rate, the higher magnitude of slide in commodity prices (15 per cent in case of crude oil since June peak) will have a cumulatively higher impact on inflation than the weakness in rupee (2.6 per cent since crude oil's peak in June).

So far as economic growth indicators are concerned, indications on the industrial production front are nothing to write home about. The index of industrial production (IIP) climbed to a 12-month high of around 20 per cent in May year-on-year but it is up just 1.7 per cent when calculated for the same month in 2019 before the coronavirus hit the country. The growth in the index of industrial production (IIP) decelerated in May from 6.5 per cent in April over the corresponding month of 2019.

However, indications on the services front are not as disappointing. The S&P purchasing managers' index (PMI) for services rose to an 11-year high of 59.2 in June.

Against this backdrop, the MPC would meet from August 3 to 5 to decide on the policy rate and liquidity measures. How will it strike a balance between reining in inflation and not sacrificing the nascent economic recovery?

ICRA chief economist Aditi Nair said global commodity prices are falling, which would pull down part of retail inflation. Some of it may be negated by the depreciating rupee for the past two weeks.

"Even then we have to watch services inflation as demand is strong for this segment. In our view, MPC may raise the repo rate by 60 basis points in the next two meetings after which it will take a long pause," she said.

India Ratings chief economist Devendra Pant said what matters for inflation is imported price in the rupee term. "While falling global commodity prices are a relief, rupee depreciation has negated a part of the decline of the dollar price of commodities. Moreover, the inflation is calculated in year-on-year terms and in relation to last year prices are still elevated," he said.

As such, he believed that despite flattish retail inflation in May and June, RBI may hike policy rates by 25-35 bps in August 2022.

Bank of Baroda Chief Economist Madan Sabnavis said MPC will look at existing inflation and outlook and it looks high at seven per cent.

"Therefore, RBI may hike rate by 25 bps. The net effect of depreciation and low commodity prices may be marginal and limited to specific sectors where no natural hedge is there," he said.

Sakshi Gupta, principal economist at HDFC Bank Treasury, said the MPC is likely to continue frontloading its rate hikes and is expected to raise rates by 50 bps in its August policy.

"Inflationary risks are moderating but prints are likely to remain close to seven per cent over the coming 2-3 months, nudging the RBI not to take its foot off the pedal for now despite moderating commodity prices and mixed signals on the growth front," she said.

Kumar of QuantEco Research said he continued to expect the MPC to deliver another cumulative 100 bps rate hike by December 2022. "Out of this 40-50 bps increase can be expected to happen in the August 2022 policy review," he said.

The net effect of falling commodity prices and depreciating rupee along with satisfactory progress on monsoon will offer marginal comfort to the MPC on the inflation outlook, he said, adding he does not yet expect the RBI to revise its FY23 inflation projection of 6.7 per cent as uncertainty on inflation drivers continue to persist.

Nair cautioned against over-tightening as domestic demand is uneven.

On the impact of the expected Fed move to raise interest rates on Wednesday, Nair said she anticipates that the MPC rate hikes will be driven by domestic inflation growth dynamics and not overly swayed by the size of the Fed rate hike.

Kumar of QuantEco said Fed is once again expected to prescribe another strong dose of 75 bps rate on Wednesday. "This will continue to keep other developing markets and emerging markets currencies on the backfoot," he assessed.

It should be noted that if the retail price inflation remains above six per cent on average for the next three months, the RBI will have to explain to the government in writing the reasons for its failure to keep the rate of price rise below six per cent, suggests remedial measures, and give a timeframe when it would fall below six per cent.