According to a Societe Generale India economist, the Reserve Bank of India will need to shift its focus away from inflation and toward supporting growth sooner rather than later.
“While a slower growth is a necessity to curb inflationary pressure, RBI would not be in a position to follow the Fed step for step as growth concerns gain currency, what with multiple agencies announcing a major downgrade in their India growth expectation,” Kunal Kumar Kundu said in a note. “And with unemployment rate showing signs of inching up again, after a modicum of moderation, the focus of the central bank has to shift to growth recovery from inflation control sooner rather than later.”
As the RBI has failed to meet its price mandate, with retail inflation remaining outside the target band for three consecutive quarters, several economists have raised their expectations for the so-called terminal policy rate to 6.5 percent or higher. Retail inflation increased to 7.41 percent in September from 7.00 percent in August, according to government data released earlier this week.
The recent higher-than-expected India inflation print validates Kundu's belief that recent price cuts in the upstream sector will not translate into price cuts in the downstream sector.
“Companies would prefer to recoup the lost margin when input costs were surging while lack of their pricing power meant a dent in margins,” he added.
Rising food prices have a much greater impact on household spending power, with food accounting for nearly 40% of the total consumption basket, according to the economist.
The greater challenge for the central bank, however, is the firming up of core inflation, he added.
Since early May, the RBI has raised the key policy repo rate sharply, raising it from a record low of 4% to 5.9% now. The banking system's liquidity surplus has also shrunk, and most pandemic-related easing measures have been reversed.
Meanwhile, multilateral agencies have reduced India's economic growth forecasts in the face of a slowing global economy, sharp monetary tightening in major economies, and the resulting financial market volatility.
The Federal Reserve is expected to continue raising interest rates sharply as inflation in the world's largest economy accelerates, strengthening the dollar and harming emerging market assets.
According to Kundu of Societe Generale, elevated food and crude prices, as well as a weak currency, will potentially add to the intensity of India's inflation tailwind in the short term.
He expects the RBI to raise interest rates by 35 basis points and 25 basis points in the next two meetings, bringing the terminal policy rate to 6.5 percent before calling an end to the current rate hike cycle.