Retail inflation may settle at 5.7-6.9% in FY23 after fuel duty cuts

Economists expect 40-50 bps hike in repo rate by MPC next month

After hiking the repo rate by 40 basis points (bps) in its off-cycle decision, the Reserve Bank of India (RBI)'s monetary policy committee (MPC) is likely to decide on the exact rate hike on the basis of its inflationary expectations at that point of time.

Retail price inflation touched a near eight-year high of 7.79 per cent in April, the fourth consecutive month when the rate of price rise was above the MPC's six per cent upper tolerance level. On the other hand, wholesale price index (WPI) inflation zoomed to a series high of 15.1 per cent that month, and some part of it could spill over to CPI in the months ahead.

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After the Centre's decision to slash excise duty on petrol by Rs eight a litre and on diesel by Rs seven a litre, economists revised their earlier projections on retail inflation slightly downwards, but still believe that the rate will remain elevated.

For instance, HSBC chief economist India Pranjul Bhandari now says CPI will still likely average well above the RBI's 6 per cent upper tolerance limit in FY23. She says the oil pump price cuts will lower inflation by 0.2 percentage points directly and by an overall 0.5 percentage points over time as lower costs feed into food and core inflation.

Before the excise duty cuts, she had said the rate would be over 6.8 per cent.

India Ratings chief economist Devendra Pant expects retail inflation to average at a nine-year high of 6.9 per cent in FY23.

Bank of Baroda chief economist Madan Sabnavis now believes CPI inflation rate is likely to average 5.8 per cent this financial year. Earlier, he had pegged it at about six per cent.

RBL Bank chief economist Rajni Thakur says since geo political uncertainty and Covid-related supply disruptions, the two key driver of price pressures that led the surge in energy prices, are both exogenous for now, inflationary projections currently are largely momentum based.

However, there are multiple moving parts in the inflation trajectory, including fiscal and monetary response, which are yet to play out completely, apart from the momentum push.

"The current momentum indicates inflation levels peaking by September at well above 6 per cent level before easing off. This year we should also see wholesale and retail prices converging before they moderate to 5 per cent levels in 2023," Thakur says.

Of course, any development on the key external price drivers and domestic responses to dynamic conditions can potentially change the inflation outcome, largely in the second half of the fiscal year, she adds.

Thakur pegs inflation rate at 5.75 per cent for FY23 against six per cent projected earlier.

Icra chief economist Aditi Nayar says the high WPI inflation is being driven by commodity prices, which will keep CPI inflation sticky until the conflict subsides, although the excise cuts on fuels are a welcome relief.

She sees CPI inflation averaging at 6.5 per cent this financial year.

Ranen Banerjee, government sector leader; PwC India, projects the CPI inflation rate to average at about 6.5 per cent.

"The factors that would help are the coordinated quantitative tightening by the monetary authorities across US and Europe having an impact on demand side leading to reversal of the commodity cycle, forecast of good monsoons and a good Rabi output and fiscal measures on reduction of taxes on petroleum products," he adds.

He says in the event oil prices do not ease and the conflict continues in Ukraine, one can expect average CPI inflation of around 6.75 per cent  across the first and second quarters of FY'23, taking into account the excise duty cut by the central government and sales tax cuts by some of the state governments.

"If monsoons are good and there is am abundant Rabi harvest, then food prices may ease a bit locally and, combined with the lagged effect of monetary policy tightening by RBI anchoring inflation expectations, we can expect inflation to pull back to 6-6.5 per cent in Q3 and Q4," he said.

Sabnavis says the transmission of WPI to CPI inflation will depend on how manufacturers pass on costs.

"It is not done immediately but only over a period of time. FMCG manufacturers have had one round of price increases. In these times, they will not do so again," he believes. 

Sabnavis thinks CPI will be about 6.4 per cent in Q1, 5.8 per cent the following quarter, 5.5 per cent in the third quarter and 5.3 per cent in the fourth quarter.

QuantEco Research chief economist Shubhada Rao said, "Notwithstanding the excise cut, we continue to hold on to our FY23 CPI inflation expectation of 6.1-6.3 per cent, but with risks evenly balanced now (versus upside risks earlier)."

The moves MPC is expected to make:

Nayar says the excise cuts have distinctly lowered the probability of highly front-loaded rate hikes.

"We expect the MPC to hike the repo rate by 40 bps in the June review and 35 bps in the August review. That will revert us to the pre-pandemic level of the repo rate," she says.

After that, the Committee should take a pause to see the impact on economic growth. "We see a terminal rate of 5.5 per cent by mid-2023. Overtightening is not warranted in the current circumstances as inflation is being fuelled by global supply side factors, and may needlessly sacrifice growth," she says.

Bhandari says she expects the MPC to hike the repo rate by another 40 bps in June, taking it to 4.8 per cent.

"Thereafter we expect the RBI to move to a series of lower quantum repo rate hikes of 25 bps each, taking the repo rate to 6 per cent by mid-2023," she says.

Pant says believes the MPC will raise the policy rate by at least 75 bps in the rest of FY23--50 bps in June and another 25 bps in October.

"The hike could also be 100-125bps (during the rest of FY23), but this will depend on incoming data, policy actions by global central banks, global geopolitical situation and its spill over effect on the India economy," Pant says.

Along with it, the cash reserve ratio could also be hiked by 50 bps to 5 per cent by FY23-end, he adds.

Thakur believes the MPC will hike the repo rate by a total of 100 bps over next two meetings in June and August.

"This will bring the repo rate at 5.40 per cent, a little above the pre-Covid level of policy rates. The base case expectation is for RBI to opt for a 50 bps hike in each meeting, but given the urgency to manage price pressures currently, a more aggressive 75 bps hike in June, followed by 25 bps hike in August can’t be ruled out at this time," she says.

Thereafter, the central bank will likely pause for one or two meetings to re-access the macro dynamics and decide in favour of another round of two hikes of 25 bps each to move real rates in the neutral zone.

The terminal rate in the cycle is thus expected to be close to per cent by the start of FY24, Thakur says.

Banerjee expects a 50 bps increase in repo rate in the June MPC meeting.

"The subsequent actions will be data dependent and mirror the pace of rate increases by the US Fed with a lag," he says. 

Table: Average CPI inflation projections for FY23 

RBL Bank	5.57%
BoB	5.8%
QuantEco Research	6.1-6.3%
Icra	6.5%
PwC India	6.5%
HSBC	Over 6.8%
India Ratings	6.9%

Source: Respective agencies