The odds of a rate hike had, therefore, risen and the Monetary Policy Committee (MPC) unanimously decided to hike the repo rate by 25 bps while maintaining a neutral stance. Neutral stance implies the RBI wants to keep its options open in the wake of domestic and global uncertainty.
Inflation based on the Consumer Price Index (CPI) rose to 4.6 per cent in April, up from 4.3 per cent in March, reversing a three-month trend. Though food inflation was marginally down, fuel inflation rose, led by a surge in petrol and diesel prices. Core inflation (CPI excluding food, fuel and light, petrol and diesel) was the primary driver of overall inflation in April, as it rose to 5.7 per cent from 5.2 per cent in March.
The first risk to inflation that is playing out is spike in crude prices. Crude oil prices rose by 18 per cent last fiscal and we expect them to rise by around 23 per cent this fiscal.
Oil prices impact consumer inflation via first- and second-round effects. Due to market linking of domestic fuel prices to global prices, the first-round effects are felt immediately, as is happening right now. Plus, the asymmetry in excise hike and reduction (excise was raised when crude oil prices fell and are not being cut when they raising) too implies higher first-round effects. The second-round effects will depend on a continuation of growth momentum and whether the RBI maintains its fiscal 2019 growth forecast at 7.4 per cent.
The second key risk is from food inflation, which has a much higher weight in CPI but is currently benign. There could also be pressure on food inflation if elements of the MSP announcement, such as setting it at 1.5 times the cost of production, extension of MSP to all kharif crops, and assuring at least MSP is paid to all farmers, together with rise in import duties are implemented. All this will need monitoring. Additionally, a depreciating rupee and firming metal prices also put upward pressure on inflation.
The gross domestic product data for fourth quarter of fiscal 2018, released recently, shows the economy is in a recovery mode. With growth picking up and core inflation rising, the ‘output gap’ is narrowing, the RBI noted.
Inflationary expectations, which are generally adaptive, have also started lifting. IIM Ahmedabad’s business inflation expectation survey for April 2018, released last week, suggests an increase in “year ahead” CPI expectation. The RBI’s household inflation expectation survey for May 2018 too reports a rise in ‘year ahead’ inflation expectations by 130 bps. CRISIL expects CPI inflation at 4.6 per cent for fiscal 2019, compared with 3.5 per cent in the preceding fiscal.
The bottom line: brace for higher borrowing costs.
Dharmakirti Joshi is Chief Economist, CRISIL.
Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.