Why RBI may hold rates, despite inflation breaching the target band

Even as CPI inflation breached the upper end of the 2-6 per cent band in February, a policy rate hike at this juncture appears remote. The Reserve Bank has projected inflation for 2021-22 is 5.3 per cent, with Q4′ 2021-22 at 5.7 per cent in its February statement from 5.1 per cent during 2021-22 and 5.3 per cent in Q4’2021-22 made in the June policy statement.

The Reserve Bank has kept the policy rate unchanged at 4 per cent since May 2020 and continued with its accommodative stance to ensure adequate liquidity to support growth and durable economic recovery.

Though the Russia-Ukraine was would be impacting the most through the energy channel, fall in global crude prices (Brent) by over 15% in the last one week from a peak of $127 a barrel on March 07 to $ 107 a barrel could be a comforting factor crude prices. Prices of iron ore and aluminum, which India imports also fell by 3-6 per cent during the week.

Even if crude prices were to rise, a 10% change in India’s crude basket could impact as much as 20 bps to CPI inflation, according to QuantEco Research. But a headroom to adjust excise duties can delay the pass-through of the already elevated global prices to pump prices.

“Even though fiscal consolidation is underway, there is still some stimulus in the economy that will last through 2022-23, as estimates of the fiscal impulse suggest,” said RBI deputy governor Michael Patra in a speech last week.

Also, food inflation is expected to remain a major source of comfort on the CPI front with prospects of robust rabi arrival backed by strong rabi sowing acreage (at 700 lakh hectares), adequate buffer stocks along supply-side interventions taken by the government in case of edible oil and pulses, according to Acuite Ratings and Research.

The global surge in food prices may have a limited impact on CPI back home.

” The surge in food prices globally will likely have a very limited impact on India given its closed food markets and ability to use price controls,” said Rahul Bajoria, chief India economist at Barclays Capital. ” We think retail prices can be shielded through fiscal measures.

For example, fertiliser subsidies may be increased, excise duties on gasoline may be reduced, and the government may contemplate providing subsidised cooking oil in the interim” Barclays expects that the spike in global food prices is unlikely to materially impact food prices in India; we expect the only visible price impact to be in edible oils and to an extent cereals.

“While the fallout of the geopolitical situation is being assessed and will be factored into our projections, it is reasonable to treat it as a supply shock at this stage in the setting of monetary policy,” Patra said.

“This statement reiterates our view, that as the ongoing crisis exerts pressure on growth recovery and CPI inflation, we expect the RBI to continue to focus on the former & stay accommodative for longer even if inflation stays elevated,” said Astha Gudwani, India economist at Bank of America Securities. “For now, we see the RBI MPC on hold on all rates in the April 8th policy”.