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OUTLOOK ON INFLATION

RBI hiked the repo rates by 50 basis points on June 9, 2022; and changed its stance to withdrawal of accommodation to control inflation.

Crude oil: The government has levied a tax of Rs 6 on petrol and Rs 13 on diesel on export of these fuels. CPI inflation for the month of June is around 7.04%

Food Inflation: is currently running at 7.87 % , which can cause CPI inflation to be generalized as worker demand higher wages and producers pass on higher costs to the end consumers. To break this chain, Government has banned wheat and sugar exports.

Government has also removed import duties on coal and imposed 15 % export duty of steel products. Steel prices has fallen by 20 % from its peak due to lower export demand and arrival of the monsoon which reduces construction activity. However, there is still incomplete pass through of fuel prices and electricity tariffs to end consumers.

Monetary policy requires to be kept tight to reduce the pass through of these shocks to discretionary consumer demand. Producers are unable to pass on these price increase to the end consumers as reflected by the EBITDA margins of consumer companies.

RBI Governor expect 4th quarter CPI to average 5. 8 % and by the beginning of 2024, CPI inflation is expected to be at 4 %. Metal and food index has fallen from their peak and individual items are down by 15 % to 20 %. If this trend sustains, CPI inflation may fall further in the coming months.

OUTLOOK IN A NUTSHELL

Liquidity in the Indian banking system continues to be adequate with above Rs 2 Lakh of surplus and government balance with RBI above Rs 4 Lakh crores.

Credit growth in the Indian economy is 13.2% more than double the growth of 5% last year. Liquidity should come back below Rs 1 Lakh crores in the fourth quarter of the current financial year due to currency leakage, FII outflow and credit growth in the economy. This fall in yields in money market papers may be a short-term phenomenon.

The yield curve has flattened above 3 years. The one-year rates are now pricing repo rates at 7 % levels, which is reflected in one year certificate of deposit rates of banks trading at 6.60 % levels (see chart) , the yield curve is steep up to one year segment, Markets expects RBI to hike rates in every policy meeting by 25 basis points each , with terminal repo rates at 7 % levels in the next one and half year. The pricing of rate hikes seems to be excessive given that GDP growth for the last year is only 1.5 % above pre pandemic levels. Due to synchronized rate hikes and liquidity withdrawal by central banks, we expect global growth slowdown and RBI not able to hike rates beyond 6.5 % levels.

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