Inflation expected to persist in India despite surprising rate hike by its central bank
05/10/2022 / By Kevin Hughes
India’s central bank raised its key policy rate for the first time since June 2018, a surprising move that led to an extensive selloff in bonds.
But an economist expects the inflation to continue at least until the end of the year. Upasana Bhardwaj, senior economist at Kotak Mahindra Bank, said in an interview with CNBC that inflation in India will probably persist to flow above six percent for the rest of the year despite the startling rate hike.
The Reserve Bank of India (RBI) on May 4 surprised markets by increasing the key borrowing rate for the first time in almost four years.
The central bank increased the so-called repo rate, which is the rate at which the RBI lends to commercial banks, by 40 basis points to 4.4 percent from a record low of four percent. The monetary policy committee stated that it will “remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.”
Bhardwaj predicted that inflation won’t relax despite expected further rate hikes. She forecast that the central bank could increase n additional 100 basis points until the end of this year.
The United States Federal Reserve was also expected to increase rates by 50 basis points following a meeting on May 5. (Related: The Federal Reserve hides price inflation, but why?)
To tighten banking system liquidity, the RBI raised the cash reserve ratio by 50 basis points to 4.5 percent of aggregate deposits.
In the inflation data issued last April 12, the headline consumer price index (CPI) print for March started at seven percent (60 basis points above consensus expectations) driven by an upside surprise in food prices. Food inflation rose to 7.5 percent year-over-year, the highest since November 2020, compelled by broad-based increase in food prices. Core inflation increased to 6.3 percent year-over-year, driven by a 7.5 percent year-over-year (7.1 percent year-over-year in February) increase in core goods inflation. Core services inflation almost remained flat at 4.8 percent year-over-year (4.7 percent year-over-year in February).
While the RBI did not provide up-to-date inflation or growth forecasts with its recent policy statement, most banks continue to forecast inflation to stay higher for longer and materially above the RBI’s previous issued forecast for the second half of 2022.
Goldman, in its postmortem letter, stated that the latest off-cycle hike suggests the RBI will now carry out a quicker and more critical monetary policy tightening cycle. It now predicts the RBI to raise the policy repo rate by 50bp further in the June 2022 meeting, followed by 25bp hikes each in August, October and December meetings.
“We thus forecast cumulative further 125 basis points repo rate hikes in 2022, with an additional 100 basis points repo rate hikes in 2023. On a cumulative basis, we now forecast 265 basis points of rate hikes in this cycle from 200 basis points earlier,” Goldman said.
Automobile and housing sectors will be hit hard by stunning rate increase
Deepak Jasani, head of retail research at the Mumbai-based HDFC Securities, stated that India’s interest rate-sensitive sectors like automobiles and housing will be hit specifically hard by the stunning rate increase by the central bank. He added that while the RBI’s rate hike was anticipated, the timing was a surprise, with stocks already in shaky territory because of inflation and the war in Ukraine.
The S&P BSE Consumer Durable Index was -3.8 percent at a two-month low; S&P BSE Realty Index was -3.4 percent; S&P BSE Auto Index was down at 2.5 percent; benchmark S&P BSE Sensex and gauge of bank stocks went down at 2.3 percent.
The Indian economy rebounded strongly from the Wuhan coronavirus pandemic with one of the world’s quickest growth rates, but is now confronting soaring costs as worldwide commodity prices shoot up.
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