To avoid stagflation, RBI needs to start hiking rates: Aurodeep Nandi, Nomura

“While managing inflation, you cannot tackle something like oil but what you can do is tackle the broader pressures that are there in the economy. In such a situation, if you want to prevent a stagflation kind of situation where growth slows and then your inflation is quite high, the central bank needs to come in and start hiking rates,” says Dr Aurodeep Nandi, India Economist, VP, Nomura. Edited excerpts:


Nomura has put out a report which says that India will be the worst hit in Asia from the Ukraine crisis. Can you elaborate on that?
Well, the reason is actually quite simple as India within Asia is one of the largest importers of oil. So, any such geopolitical tensions where markets get spooked and oil prices go up, India remains quite vulnerable. There are a couple of things: Crude oil prices have been rising even before Russian tanks rolled into Ukraine because global travel demand has been picking up and economies are getting out of Covid. We have had what is known as greenflation, so fewer investments in fossil fuels. There are other pressures also on crude oil prices which have been elevated and then this has been sort of the straw that broke the proverbial camel’s back. Now, as far as, India is concerned, there are two concerns. One, since November petrol prices have not risen. Petrol, diesel and LPG prices have been kept constant despite crude oil prices rising quite sharply. At some point, possibly in March, once the state elections get over, these prices will have to be passed on to consumers. And so when that happens, we have got that correction that needs to happen.

We are in election time, so what is the number that needs to increase to sort of catch up to where crude is?
We estimate that the petrol consumer price index would go up by anywhere around 10% month-on-month. This could be staggered, so it is not like they are going to just wake up and raise prices in one shot. You will have these daily increases of 20-30 paise possibly but also it could be sort of staggered over the course of a couple of months. We see a rise of around 10% or so because there is a huge gap currently between the rupee price of crude oil and actually what we are paying at petrol pumps. But the caveat is that maybe the government would like to come in and say we will cut excise duties. Now, that is a two-edged sword because already the government has cut excise duties by five rupees per litre. If I am not mistaken, that has cost the exchequer around 0.5% of GDP. If the government again comes in and says alright crude oil prices have gone up, we are going to cut excise duties further in order to take care of that, that would mean a fiscal hit. Now, if you still want to maintain your fiscal deficit target of 6.4% of GDP, you need to cut down capital expenditure. In order to make for this new excess money that you are going to spend around 0.5% of GDP, in taking care of cut in excise duties, there are really no easy choices as far as this is concerned.

What are the options India has as we enter perhaps a prolonged period of very high crude prices and what could be the next policy steps that you foresee?
I think none of the policy steps from hereon is costless. If you want to cut down excise duties at the pump level, that is going to increase the fiscal deficit. If you want to control the fiscal deficit, you need to cut down on capital expenditure. Now one of the reasons why the budget was a success is because it focussed a lot on capital expenditure. It is one of those things where there are a limited amount of policy options but I think the thing that sort of is really interesting in this is what monetary policy is going to do.

The RBI has set an inflation projection of 4.5% for FY23. That sounds really nice as 4.5% is very close to the target of 4%. They argue that look the growth is slowing, so overall we should at least keep rates where they are. Somewhere in the middle of the year, the RBI will have to be cognizant of the fact that look inflation is actually going nowhere close to our focus and target but in fact, is actually inching much higher and which is why we believe that despite the dovish guidance, the central bank is likely to raise rates by as much as 100 bps this year, with the pivot happening somewhere in June.

While managing inflation, you cannot tackle something like oil but what you can do is tackle the broader pressures that are there in the economy. In such a situation, if you want to prevent a stagflation kind of situation where growth slows and then your inflation is quite high, the central bank needs to come in and start hiking rates.

The other aspect is that in the short term there are growth drivers. We have got high levels of government spending, services sector that is reopening, strong export growth because global demand seems to be good now. A lot of these factors might start reversing towards the second half of the year. The key ingredient to make this a successful recipe is if private capex in India picks up. Now, the positive side there is that a lot of these companies have deleveraged quite a lot so their balance sheets are relatively clean. But on the flip side, consumption demand is quite low, the capacity utilisation is low. So, a lot of these companies would not be interested in making private investments and we have not seen that pipeline pick up but if that picks up then there is hope. So yes, inflation is going to be high and yes there is something on crude oil which you cannot really solve at the domestic level but if the growth cycle sort of remains stable that could be a positive that could come in. But overall we are bearish on growth in the second half of 2022.