rate hikes: Brace for more rate hikes as Russia war sets inflation on fire
The off-cycle MPC decision on May 4 to raise repo rate by 40 basis points was one of such steps to reduce the pain on the economy from one big increase to counter the price pressures that would have dealt a big blow to markets, said central bank observers.
Inflation after breaching the upper tolerance band of 6%, is probably accelerating due to a sustained surge in food prices, mostly due to disruptions caused by the war, necessitating a quick response from the central bank. Furthermore, the ban of export of palm oil by Indonesia came as a bolt from the blue. The hot climatic conditions across the world is likely to reduce farm output that may further accentuate price pressures.
HDFC Bank’s chief economist Abheek Barua projected April CPI (consumer price index) at 7.6%, a good 160 basis points above RBI’s upper tolerance level of 6%. The March CPI rose to 6.95% which is a 17-month high. The April CPI print would be released on May 12.
While the off cycle may have shocked markets, the central bank had prepared the market for tightening in its April policy when its priority changed from `promoting growth’ to `curb inflation’. RBI was consciously behind the curve because the economy needed more support but had to act when price rise is getting entrenched.
Inflation is at risk of becoming more generalised as the pass through of higher input costs to consumers occurs with a lag, apart from transportation and logistics,” observed DBS Group
Research led by chief economist Taimur Baig. “This coupled with the likelihood that as reopening from the pandemic is complete, the nature of inflation will shift from being purely goods driven to services-led, making price increases more enduring.”
About three-fourth of the rise in CPI was due to the war, an economist said. If war comes to an end and inflation pressure softens, RBI would likely return to its easy monetary policy as the central bank feels that the economy which was recovering from the pandemic-led stress needs more handholding.
The sharp acceleration in headline CPI inflation in March was propelled by food inflation due to the impact of adverse spillovers from unprecedented high global food prices. Nine out of the 12 food sub-groups registered an increase in inflation in March. High frequency price indicators for April indicate the persistence of food price pressures.
The MPC’s plans to return to the pre-pandemic level of 5.15% might happen swiftly, which points to at least 75 bps increase by September, the DBS note said.
The policy rate may still remain below the neutral rate, a point when the real rate becomes zero.
The rise in policy rates would certainly hamper economic recovery by curtailing demand. The RBI is ready for short term sacrifices in order to make long term growth a sustainable one.
“Inflation must be tamed in order to keep the Indian economy resolute on its course to sustained and inclusive growth. The biggest contribution to overall macroeconomic and financial stability as well as sustainable growth would come from our effort to maintain price stability,” Governor Shaktikanta Das said Wednesday after announcing the out-of-turn policy decision.