The RBI Governor said that inflation has peaked and expectations have anchored but he was careful not to say at what level have these inflation expectations been anchored. Have they been anchored at 6%. particularly now that he says it will take about two years for inflation to get back to that 4%?
I agree with the Governor that inflation has probably peaked except for the month of September when due to base effect, we will see a slightly higher inflation print but from September onwards it is coming down. All of these are largely base effects and these are predicated on some assumptions of crude at $100-$105 a barrel and certain level of metal prices etc. Food prices are very important but we are maintaining our average inflation for this year FY23 at 6.75%.
Initially the risks were balanced but now we think that even with the risk of higher food prices going forward, inflation numbers are going to come down. By Q1 of FY24, we are likely to be about 4.8% to 5% but that is pretty much the broad trajectory of inflation that will be coming down.
On inflation expectations, we have seen the three-month ahead, six-months ahead, one-year ahead inflation expectation surveys that the RBI does and those are at much higher levels but the level has come down a little bit over the last three or four surveys. So I would not go by the level of those inflation expectations which are at 8%-9% etc.
The governor also refused to be drawn when Nikunj asked him whether the pace of rate increases, which has been somewhat like a T20 match, could slow down and become more like a test match? Is the RBI likely to go a little slower because there is a thinking that even the Fed might go a little slower?
Saugata Bhattacharya: I do agree that the pace is likely to slow. The last hike was 50 bps, if at all, depending on the next inflation print coming with the policy in September end, we probably will see about a 35 bps or even a 25 bps going forward to take it up to the 5.75% level.
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On the Fed side, which is far more difficult to gauge because for the Fed it is not just a price inflation problem and the bigger headache is the labour market. It is a wage inflation problem. My own sense is they will probably not do a 75 bps hike again depending on the CPI numbers, the PCE numbers that we are going to see at the end of this week and the next set of labour prints that are going to come in.
The Fed’s problem is much more serious than that of the RBI because the labour markets are so tight that their wage inflation expectations are likely to drive the Fed’s growth. My own sense is they are not going to let up, maybe they are not going to do the 75 bps but gradually and 50 bps and then 25 bps, they are going to keep hiking.
Markets are pricing in a Fed cut in 2023; my own sense is that is not going to happen. Even if they stabilise in 2023, they are not going to cut rates, they cannot afford to. As far as the RBI is concerned, the Governor said today that the RBI and MPC’s actions are driven more by domestic economic and financial conditions. My own sense is the frontloading part of the RBI and MPC rate hikes that has already been done. From now on, the pace is going to be much more moderate.
The governor did not mention that RBI and MPC will have to send a report to the government by September explaining what led to the failure, what are the steps that they intend to take. So what kind of “excuses” do you think the RBI will give to the government and what kind of remedial action will they suggest to get inflation back under 4%? Will they tell the government it is going to take us two years to do it?
The first reason that the statement to the government is likely to be of course the unexpected cause of the commodity, energy price shocks that came in after the Ukraine crisis. Remember that even before that in February, our own and the survey of professional forecasters predicted that by April, inflation would be coming down.
At that point in time, the average inflation for the year was about 5.7%. So the first reason is the unexpected shock that came in from the Ukraine crisis. Secondly there are three components to that, which the RBI has to write to the government. One is what are the key causes of the failure to not fall below the 6%; secondly over what time period do they expect the rates to come down and thirdly, what is the RBI and MPC likely to do to bring inflation down to the target 4%.
The path to 4% is likely to be relative and will easily go on into probably FY25. Next year, our forecast for average inflation, given the economic and financial conditions now prevailing, is 5%. My own sense is that the fiscal policy side will probably need to chip in a little bit more to prevent the Reserve Bank and MPC from having to hike rates to a level which might actually lead not just to a growth slowdown but some level of financial sector instability in the sense of banking and NBFC asset stress.
That probably needs to be avoided and remember this time around, transmission has been very fast. A large part of the banks’ loan portfolios are external benchmark linked which is repo linked. The rates have gone up very quickly. Both of these considerations on the fiscal side use some of the fiscal levers, excise, taxes, other tax cuts, etc, to bring down price pressures on certain sets of commodities.