High inflation may force RBI to extend rate pause

Mumbai: With retail inflation breaching the upper bound of the Monetary Policy Committee (MPC) and with the government surpassing its fiscal deficit target, the MPC of the Reserve Bank of India (RBI) is likely to maintain a status quo on policy rates next month. Some economists even expect the central bank to change its stance from ‘accommodative’ to ‘neutral’ at its upcoming monetary policy on February 6.

Both Consumer Price Index (CPI) inflation and Wholesale Price Index (WPI) inflation rose on the back of higher food prices. Retail inflation rose to over five year high of 7.4 per cent in December 2019, breaching the upper target limit of 6 per cent. The increase in inflationary pressure emanated from a sharp rise in onion prices (4.2 times) due to crop damage; firming global commodity indices, particularly the FAO food price index and crude oil prices besides mobile tariff hike of 15-50 per cent.

While food prices may soften from January onwards owing to the arrival of the kharif produce and robust rabi sowing, the moderation could be gradual as the food inflation has become more generalised. Despite sluggish economic activity, core CPI inflation may not moderate much as the full impact of the telecom tariff is yet to play out, said experts.

“We now expect CPI inflation to trend towards 6.2 per cent by March 2020. Even though we acknowledge that the output gap remains negative and that any growth recovery is likely to be slow and prolonged; the MPC is expected to remain concerned about the significantly high CPI inflation. With inflation likely to remain 120-320 bps above the MPC’s comfort zone of 4 per cent until November 2020, we believe that the MPC will find it difficult to ease its monetary policy further, especially given the risks of fiscal slippage. Persistently high headline inflation has meaningfully increased the probability of a shift in the policy stance from accommodative to neutral in the upcoming MPC meeting,” said Upasna Bhardwaj, chief economist at Kotak Bank.

“Real rates have now turned negative at 220 basis points and the possibility of fiscal slippage in FY20 is a signal that the rate easing cycle has come to an end. However, we believe that it will be too soon for the RBI to change its stance to tightening as the inflation is more or less transient in nature,” said Sunil Tirumalai, analyst at Emkay Global.

The RBI has shocked the markets by holding rates steady at its Dec. 5 meet.