The Monetary Policy Committee (MPC) is due to announce its policy decision in its scheduled Monetary Policy review meeting at the end of September. We foresee another rate hike, after the cumulative increase of 140 basis points (bps) seen since May 2022.
However, the quantum of the hike is likely to be smaller than the 50 bps each seen in the last two meetings. We also see a low likelihood of the FY23 CPI inflation forecast being revised from 6.7 per cent, and firmly believe that the growth projection does not need to be lowered from the current 7.2 per cent.
Since the last policy review, the big data release has been India’s GDP growth for Q1 (April-June) FY23. GDP expansion jumped to a four-quarter high of 13.5 per cent in year-on-year (y-o-y) terms in Q1 FY23. This was aided by a low base owing to the second wave of Covid-19 in India in Q1 FY22, and a robust revival in expenditure on contact-intensive services. While the print was largely in line with our estimate, it undershot the MPC’s projection of 16.2 per cent for that quarter.
Notwithstanding the double-digit y-o-y expansion, real GDP exceeded the pre-Covid levels of Q1 FY20 by just 3.8 per cent in Q1 FY23. Further, the trade, hotels, transport, communication, and services related to broadcasting (THTCS) sub-sector, the worst impacted segment during the pandemic, trailed the pre-Covid level by 15.5 per cent, reflecting the incomplete recovery in contact-intensive services.
For the ongoing quarter, the moderation in commodity prices from their peaks seen in mid-June 2022 is a positive for business margins and value-added growth. However, the high frequency data for July-August 2022 confirms an entirely expected slowdown in the y-o-y growth in Q2 (July-September) FY23, relative to Q1 FY23, on account of a normalising base, amid uneven expansion across sectors.
Additionally, risks owing to a lower kharif output following the lags in sowing of rice and pulses, and a weaker external demand, as evinced in the decline in non-oil exports in August 2022, have come to the fore.
Nevertheless, we foresee a y-o-y GDP growth of 6.5-7.0 per cent for Q2 FY23, higher than the MPC’s current projection of 6.2 per cent, with an upside stemming from the continuing recovery in services demand and the correction in key commodity prices.
Moreover, we expect a higher growth in H2 (October-March) FY23 of 5.0-5.5 per cent vis-à-vis the MPC’s projection of 4.0 per cent, partly based on our view that government and private capex will be back ended. Therefore, we continue to expect GDP to expand by 7.2 per cent in FY23, and don’t see a case for a downward revision in the MPC’s projection.
While CPI inflation had cooled to 6.7 per cent in July 2022 from an average of 7.3 per cent in Q1FY2023, we expect a base effect-led uptick to 6.9-7.0 per cent in August-September 2022. This implies an average CPI inflation print of 6.9 per cent in Q2FY2023, modestly lower than the MPC’s projection of 7.1 per cent for that quarter.
The correction in commodity prices bodes well for easing domestic input cost pressures and the core-CPI inflation in the near term. In particular, crude oil prices have eased appreciably, although this has not transmitted into a change in the retail prices of fuels. Regardless, we remain circumspect regarding the sustainability of these levels with winter approaching in the Northern Hemisphere.
In our view, the robust demand for services domestically remains a key monitorable, given its significant share in the CPI basket (services: +23.4 per cent). In addition, the lag in kharif sowing is a concern, which has recently prompted a 20 per cent export duty on various grades of non-basmati rice.
On balance, we anticipate that the CPI inflation will trail the MPC’s Q3(October-December) FY2023 projections of 6.4 per cent, based on our projections of sub-6 per cent prints in November 2022 and December 2022. For Q4(January-March) FY23, our forecasts are similar to the MPC’s, which informs our average forecast of 6.5 per cent CPI inflation for FY2023.
However, we do believe that the MPC is likely to err on the side of caution, given the upside risks on account of food and services items in the CPI basket, and retain its baseline CPI inflation forecast at 6.7 per cent.
Given the emphasis placed by the MPC on anchoring inflationary expectations in its August 2022 policy meeting and the RBI Governor’s comments on ensuring that the CPI inflation moves closer to the target of 4.0 per cent over the medium term, we believe that rate hikes will continue until there is visibility that CPI inflation readings will imminently fall below 6 per cent.
However, with the undershooting in growth relative to the MPC’s projections for Q1 FY23 and the likelihood of a slightly lower-than-projected CPI inflation print for Q2 FY23, we expect the MPC to temper the quantum of the rate hike to 35bps in its September 2022 meeting from 50bps in its last two meetings. Finally, the merchandise trade deficit prints for July and August have surged compared to the average monthly levels seen in Q1 FY23, and India’s current account deficit (CAD) is expected to widen further to an eye-watering 5.0 per cent of GDP in Q2 FY23 from the 3.6 per cent expected in Q1 FY23.
Given this backdrop, the RBI Governor’s comments around the external sector would be closely watched, following the assurance in the previous meeting that the CAD was expected to remain within manageable limits.
The recent comments from the RBI regarding preventing excessive volatility and anchoring expectations around the depreciation of the INR suggest that the rupee is likely to trade in a relatively narrow band in the near term. With the revival of FPI equity inflows, we expect the INR to trade between 78.5-81.0/$ in the remainder of CY22, amid global headwinds
The author is Chief Economist with ICRA Limited