Does CPI Inflation At 6.83% Warrant A 'Rate Cut' Or 'Pause' From RBI In October policy?

Like music to the ears, India's consumer price index (CPI) inflation has eased sharply to 6.83% in August 2023, better than what the market has forecasted. The drastic decline in inflation is due to steep moderation in food inflation especially in vegetable prices. This has turned all heads towards RBI who will be announcing the next bi-monthly monetary policy outcomes in October. RBI is in an inflation trajectory central bank, and a drop in CPI comes as good news as it creates more room for rate cuts. However, there is more to an eye than meets!

Let's do a few checks and unchecks!

CPI has shown signs of easing, checked. Food inflation too squeezed lower, checked. However, the average run-rate of inflation continues to be elevated.

Retail price inflation in India dropped to 6.83% in August, better than market forecasts of 7% --- which does come as a relief, especially after CPI touched a 15-month high of 7.44% in July due to a behemoth rise in prices of tomatoes and onions. Also, inflation is better than the 7% rate recorded in August 2022.

Coming to food inflation, it has relaxed to 9.94% in August 2023 compared to the previous month's print of 11.51% which was the highest level since January 2020, before the Covid-19 outbreak.

Is inflation below RBI's target limit? Has seasonal impact on food categories like vegetables pulses and spices disappeared? NOPE

Inflation still stays sharply above RBI's medium-term target for consumer price index (CPI) inflation of 4% within a band of plus and minus 2%. Hence, RBI's upper tolerance limit for CPI is 6%. And inflation continues to stay above this upper limit for the second month in a row.

Hence, experts believe RBI will continue to be cautious in upcoming policy. This also shuns the possibility of a rate cut, but the easing in inflation also dims the possibility of a rate cut either. That being said, another pause in policy rates is most likely from RBI in October.

Here's what experts say:

Akhil Mittal, Senior Fund Manager - Fixed Income, Tata Asset Management said, "The headline CPI inflation came in at 6.83% YoY against an expectation of 7.10%. The fall can be largely attributed to steeper fall in food inflation led by fall in vegetable inflation. Core inflation has come @ 4.8%, in line with expectations. While this number is somewhat a relief, the average run-rate still continues to remain above RBI estimates. Elevated cereal inflation, along with uncertainty around monsoons, will keep RBI on guard and hence we expect caution to continue from RBI end."

Suvodeep Rakshit, Senior Economist, Kotak Institutional Equities highlighted that cereals and pulses continued to see upside and we need to be cautious of this trend being more sticky. Core inflation at 4.9% was similar to July print though tad higher than our expectation.

Further, according to Vivek Rathi, Director Research, Knight Frank India, seasonal impact on food categories like vegetables pulses and spices continue to keep the inflation level elevated. So far between Apr-Aug 2023, CPI has averaged at 5.8%; and will likely reach the FY24 target set by the RBI in its last policy meeting. Considering that the RBI has projected Q2 FY24 CPI to be at 6.2%, it indicates that the central bank has already factored in the inflationary risks in its policy decision so far.

Looking ahead, Shlok Srivastav, Co-founder & COO, Appreciate, a fintech platform for Savings & Investment Given that the government has stepped in to curb rice and tomato exports, a gradual reduction in inflation in September and beyond is to be expected," adding,"Overall, these numbers bode well, under the assumption that seasonal factors normalise themselves. Once inflation has been steadied, the RBI should be able to bring it back to its usual comfort zone of 2-6%."

Rakshit also said, CPI inflation should moderate further to around 5.5% by December if the current trend of food prices persist. Adding he said, "We continue to expect the RBI to remain cautious as inflation remains well above the 6% mark. We maintain our call for an extended pause as the RBI watches for the domestic growth-inflation mix, food prices trend and impact on inflation expectations, and impact of global monetary policy decisions on the INR."

In its upcoming policy meeting in Oct 2023, Rathi added, "the central bank will more likely continue with a rate pause, which is crucial, as any additional rate hike could potentially dent the spending capacity of the households. Affordable housing sector is particularly dependent on a stable and benign interest rate environment and a rate pause is crucial for this segment. The tapering inflation level will provide comfort to the real estate industry as expectations around interest rate hinge on its trajectory."

The growth in industrial production is uneven across the categories. Consistent growth in the capital goods and infra/construction goods production hints at heathy investment cycle in the economy. However, slowing consumer durable goods production is hinting at slowdown in personal consumption of the households, Rathi added.

Bond markets might take a bit of relief and see slight downward movement in yields in near term. Mittal said, "The persistence of inflation and trajectory will determine the larger move. So we expect yields to remain range bound and take a slight breather from slow hardening that we have seen in recent times. We expect 10 yr benchmark G-Sec to trade in range of 7.10%-7.25% in near term."

In August, RBI decided to keep policy rates unchanged for the third time in a row since the onset of the current financial year. Accordingly, the policy repo rate under the liquidity adjustment facility (LAF) is unchanged at 6.50%. Further, the standing deposit facility (SDF) rate remains unchanged at 6.25% and the marginal standing facility (MSF) rate and the Bank Rate at 6.75%. Also, the MPC members decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

Disclaimer:

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