CPI inflation stays above RBI comfort zone

In a move that may weigh on yields across the curve, the RBI last week set a coupon of 6.10% for the new 10-year bond sale, higher than that of 5.85% for the current benchmark, after trying for months to limit it at 6%.

Retail inflation unexpectedly dropped a tad in June to 6.26% from a six-month high of 6.30% in May but still stayed above the Reserve Bank of India’s (RBI’s) tolerance level for a second straight month, as price pressure remains elevated across food and fuel segments.

With global prices of commodities, especially of oil, on the rise and the US Federal Reserve signalling its intent to raise interest rates later this year, the RBI faces tough choices in its bid to supplement growth if inflation stays sticky, despite its willingness to remain accommodative.

While the monetary policy committee is expected to retain key rates in its next meeting in August, some analysts expect the beginning of a policy normalisation in the December quarter. The MPC may also revise up its inflation forecast for the September quarter from 5.4% even though supply constraints seem to be easing, as the second Covid wave wanes and lockdown curbs get relaxed.

The latest data showed food inflation inched up to 5.15% in June, against 5.01% in the previous month, while fuel and light inflation accelerated to 12.68% from 11.86%, as petrol and diesel prices remained high. Importantly, core inflation dropped only marginally to 6.2% in June from 6.4% in the previous month.

In a move that may weigh on yields across the curve, the RBI last week set a coupon of 6.10% for the new 10-year bond sale, higher than that of 5.85% for the current benchmark, after trying for months to limit it at 6%.

Already, in the monetary policy statement last month, the central bank cautioned that the rising trajectory of international commodity prices, together with logistics costs, pose upside risks to the inflation outlook. It has projected CPI inflation at 5.1% in FY22 – 5.2% in Q1; 5.4% in Q2; 4.7% in Q3; and 5.3% in Q4 – with risks broadly balanced.

It had also suggested that excise duties, cess and taxes imposed by the Centre and states “need to be adjusted in a coordinated manner to contain input cost pressures emanating from petrol and diesel prices”.

Elevated WPI inflation (it had hit 12.94% in May, the highest in the current series with 2011-12 base year) may spill over to the retail level. However, given the battered demand condition, some analysts feel this transmission may not be substantial, if not entirely muted.

Icra chief economist Aditi Nayar said: “We expect the inflation forecasts to be revised upwards in the next MPC review, amid a status quo in the rates and stance, albeit with an underlying tone of uneasiness in the commentary. In our view, the tussle between supporting the nascent, incomplete revival in growth and preserving the anchoring of inflationary expectations will continue.”

What also adds to policymakers’ worries is the return of retail food inflation. It widened to 5.15% in June from 5.01% in May and just 1.96% in April. Chief economic advisor KV Subramanian last week expressed his concern about elevated price pressure in food articles and pointed out that last year, high food inflation was caused by supply-side factors in the wake of a Covid-induced pan-India lockdown.

Inflation in transport and communication and health moderated from the May levels but still remained elevated at 11.56% and 7.71%, respectively, in June.

Sujan Hajra, chief economist at Anand Rathi Securities, said: “For the RBI, growth will still remain the main focus. The fact of the matter is that there is still a significant amount of demand destruction and there is significant amount of excess capacity, particularly in manufacturing.”

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