CPI inflation sets the tone for another rate hike

It looks like the RBI tightening measures are working. For the month of June 2022, the CPI inflation came in at 7.01% against the consensus estimate of 7.10%. More importantly, in the last two months since the RBI started its hawkish approach to markets, the rate of inflation has fallen from 7.79% to 7.01%. That is the good news, but all is not hunky dory. Despite the best efforts of RBI, overall inflation continues to remain above 7% for the third month in a row and above the RBI tolerance limit of 6% for the sixth month in a row. 

Just as a matter of information, June 2022 also marked the 33rd consecutive month that retail CPI inflation stayed above the median 4% inflation target. During the month of June, the food inflation tapered marginally but core inflation stayed flat at 6.11%. In the last 2 months, food inflation has tapered from 8.38% to 7.75%. However, it must be remembered that this fall comes after 670 bps spike in food inflation in the 6 months prior to that. Overall food inflation is unlikely to be helped too much by the tepid Kharif season so far.

Core inflation is the real problem area for RBI

Core inflation is the residual inflation after removing the effect of food and fuel, which are more cyclical in nature. On the other hand, core inflation is stickier and takes longer to rectify. Ironically, one of the key drivers of core inflation is crude oil, due to its strong externalities and the consequent trickle-down effect. The table below captures the food inflation and core inflation over the last 13 months to give you a much better time-bound perspective of how prices have panned out.

Data Source: MOSPI / Bloomberg

On the subject of core inflation, it must be remembered that core inflation normally leaves the government and the RBI with some tough policy choices. Here is an illustration. The current battle against inflation is being driven by rate hikes. But that can only address the demand pull side of inflation. The supply push side of inflation normally has a fiscal cost in the form of duty cuts resulting in lower revenues. So, core inflation can be controlled, but it comes at a cost to the exchequer, especially in the form of lower revenues.

Million dollar question; will the RBI hike rates in August?

If the RBI has been proactive in the last two monetary policy meetings, the bigger question after this data announcement is “What next”? In May, the RBI hiked repo rates by 40 bps and CRR by 50 bps. In the regular June monetary policy, RBI hiked repo rates by another 50 bps. Now, 90 bps of rate hikes are done and with another 20 bps the COVID largesse should be largely neutralized. Will the RBI stop at that or will the RBI adopt a more aggressive approach in the August policy meet? After all, CPI inflation is sharply lower in June 2022.

Prima facie it does look like RBI may prefer to err on the side of caution. When the RBI meets in August, we can expect a rate hike of another 40 bps to 50 bps, which means it would go above the pre-COVID repo rates. That would give the RBI greater policy leeway in the future. But decisions are not India specific any longer, so RBI will also keep an eye on US consumer inflation and the US PCE inflation. If US inflation and India WPI are hinting at higher inflation, RBI may go still further. Remember, IIP is robust enough to support that!