Inflationary pressure exceeded expectations; the RBI may further increase the interest rate hike
According to the data released by the Central Statistics Office of India on May 12, India’s retail price index rose further to 7.79% year-on-year in April, which was the highest level in nearly eight years. In contrast, in March this year, the index was still 6.95%. The development of this indicator far exceeded the expectations of most economists for inflation of around 7.5% in April. India’s inflation rose in April mainly driven by higher food and fuel prices. Compared to April last year, India’s core inflation rose to 6.8% from 6.6% in March, the data showed. On the consumer side, not only did the food price index rise 8.1%, the fuel price index rose 10.80%, and clothing and other wearable goods are also rising, up to 9.85%. While on the supply side, the sale price of motor vehicles in India has been raised several times due to the rise in the prices of steel, aluminum, plastic, etc. Therefore, even excluding the impact of high price volatility in food and fuel, India’s core inflation rate was still rising in April. Nevertheless, India’s current inflation data still does not fully reflect the impact of higher international crude oil prices. India resumed nationwide retail price updates for gasoline and diesel on March 22, after stopping daily updates for nearly six months. Due to the sharp rise in international oil prices, India has been increasing the retail price of gasoline and diesel almost daily since March 22. However, due to the rapid price increase, the retail price of gasoline and diesel in India melted down again and stopped updating from April 8. This situation has continued until now. This means that the inflation data in April only contains part of the increase in the price of gasoline and diesel, and does not reflect all of it.
During the formation of this round of inflation, the Reserve Bank of India (RBI) is too optimistic about the development of this round of inflation in at least two aspects.
First, the RBI has underestimated the persistence of the current round of inflation. At the RBI’s bi-monthly monetary policy meeting in February, RBI Governor Das pointed out that the current round of inflation in India would be temporary and would peak in the first quarter and gradually decline, with the Indian retail price index (CPI) likely to fall to around 4% by the end of this year. The RBI underestimated the resilience of inflation. Indian inflation not only did not peak in the first quarter but may also continue into the second quarter. Considering that the current round of inflation has been forming since November last year, this can hardly be described as transient in any case.
Second, the RBI has underestimated the high point of the current round of inflation. The RBI predicted in February that annual inflation would be around 4.5% in FY2022-23 and that inflation would average less than 6% in January-March this year. But none of these forecasts could be realized. In the first quarter of this year, India’s inflation rate was above 6% every month. The RBI in April has revised upward the inflation for FY2022-23 to 5.7%.
Due to over-optimism in inflation forecasts, the RBI maintained a loose monetary policy stance at its April monetary policy meeting by remaining focused on promoting economic growth as the centerpiece of policy and continuing to maintain the historically low-interest rate of 4%. This came as a big surprise to market institutions.
However, the RBI has realized this situation. It held an additional monetary policy meeting in May outside the schedule and raised the benchmark interest rate by 40 basis points to 4.40%. The RBI Governor Das noted that the central bank needs to keep a close watch on inflation and make maintaining price stability a priority objective. The RBI’s rate hike in May was seen by the market as a self-correction by the RBI.
Along with this, the RBI will continue to raise interest rates in June. Currently, most economic institutions predict that the RBI will continue to raise interest rates by 50 basis points. Indian rating agency Crisil recently said in a report that with headline inflation accelerating to an eight-year high of 7.79% in April, the RBI is likely to raise rates by 1% point in the fiscal year 2022-23 as the basis for price increases in India becomes increasingly broad-based. Aditi Nayar, the chief economist at Icra Ratings, another Indian rating agency, noted that the RBI’s monetary policy committee is expected to raise the benchmark interest rate by 40 and 35 basis points in the following June and August, respectively, which, together with the 40 basis points in May, will take India’s benchmark rate up to 5.15%.
To hedge against the impact of the epidemic, India cut its benchmark interest rate by 115 basis points in 2020. This has boosted domestic inflation progress while stabilizing and boosting economic growth. Some market institutions point out that the RBI will raise the benchmark interest rate to pre-epidemic levels and move to raise rates much faster than previously expected.
