Hobson’s choice for RBI: While the rate cycle must turn, the recovery should not be a victim

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Given that retail price inflation in March reached 7% and was quite widespread, RBI should take steps to tighten the benchmark rate. Action would be warranted not only because the headline is well above RBI’s 6% target, but as Sonal Varma, Nomura India’s Chief Economics Officer pointed out, almost 70% of the under -components of the consumer price index (weighted) now exceed 4%, the midpoint of the tolerance margin. Also, based on prices in April, especially for groceries, there doesn’t seem to be any respite any time soon. Indeed, inflation, it seems, will soon be rooted in goods and services as businesses pass on additional raw material costs to consumers and, in the agricultural sector, possibly through higher PSMs. .

The central bank has already said its top priority now will be to rein in skyrocketing prices and raised its inflation forecast for the current year to 5.7%, a sharp rise from the forecast 4.5% previously. Many economists have said this may be an underestimate of the path of inflation. Additionally, RBI moved to raise short-term rates by 40 basis points, introducing the Permanent Deposit Facility (SDF) at 3.75%, and changed its stance to “focus on housing withdrawal “. This position should change to “neutral” in June, if not earlier.

The first of the repo rate hikes (by 25 basis points) is expected in June, rather than August. Afterwards, economists are considering three additional increases of 25 basis points, for a cumulative 100 basis points for the current fiscal year. Should geopolitical tensions deescalate and crude oil prices fall sharply, inflation could fall to levels below current projections of around 6.2% in FY23. Services.

However, much of the inflation is undoubtedly the result of supply shortages across a range of commodities, particularly crude oil, the price of which remains high at nearly $110 a barrel. Currently, local gasoline and diesel pump prices reflect a crude oil price of just $100 per barrel, which leaves room for increases. The big worry is the jump in food inflation in March to 7.7% from 5.9% in February. Protein inflation is one of the reasons basket is getting more expensive, but edible oil and fruit have become much more expensive. Again, rising farm input costs could keep food prices high or push them up. And as the economy opens up, pent-up demand for services could leave underlying inflation high. Although it may seem difficult, the government must step in to help RBI bring inflation under control. Late last year, the Center cut excise duties on motor fuels, forgoing about $450 billion in revenue. A similar reduction is requested from the Center and the States, especially on diesel, to stop inflation, including food inflation. This would allow consumers to spend on other products. Moreover, if interest rates rise beyond a certain point, it will surely hurt the recovery and especially small businesses already struggling with rising costs and shortages. RBI lowering its FY23 growth forecast by 60 basis points to 7.2% is worrying in itself, but even that might be optimistic. Manufacturing production remains anemic – it increased by 1.7% in February against 1.5% in January – and the performance of the capital goods segment, in particular, has been very poor.

There is no doubt that RBI’s job has become quite difficult. The concern is that growth cannot take a higher trajectory unless the private sector participates in the investments. And for that, interest rates must be affordable. The investment cycle is starting to turn and needs to be supported, as is consumer demand. Both require the cost of money to be moderate. This is precisely the central bank’s dilemma.

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