'Rate Hike' or 'Status Quo'! All eyes on RBI's August policy
Firstly, one needs to remember that RBI is an inflation trajectory central bank and its policy decisions are derived from the performance of Consumer Price Index (CPI) or retail inflation.
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RBI Monetary Policy: Good news! Rupee strengthens; this is how status quo will help Indian currency When the Reserve Bank of India (RBI) decided to hike policy repo rate by 25 basis points to 6.25% from previous 6% in June policy, experts were of the opinion that similar action is going to continue for another two policies. However, two opinions have now emerged. There is a section of analysts that believes the RBI will decide to maintain a status quo in August policy, which is scheduled for tomorrow, another section still reiterates that a rate hike is on cards. The RBI meet will be chaired by RBI Governor Urjit Patel and six-member Monetary Policy Committee (MPC).
Firstly, one needs to remember that RBI is an inflation trajectory central bank and its policy decisions are derived from the performance of Consumer Price Index (CPI) or retail inflation.
The reason behind rate hike in previous policy was due to a list of factors that surround CPI, which will keep the indicator under pressure going ahead. RBI revised and projected CPI inflation for 2018-19 to 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside.
Excluding the impact of HRA revisions, CPI inflation is projected at 4.6 per cent in H1 and 4.7 per cent in H2.
India's retail inflation for month of June has gone up to 5 per cent compared to 4.87 per cent in May 2018, according to government data released by the Central Statistics Office.
source: tradingeconomics.com
Driven by higher fuel prices and a depreciating rupee, the forecasts for June ranged from 4 per cent to 6 percent. June was the eighth straight month in which inflation was higher than the central bank`s medium-term target of 4 percent.
Considering the above, whether RBI decides to maintain status quo or a rate hike, we will have to wait and watch. But for now lets understand what is driving CPI currently, which will surround the RBI’s decision.
As per Edelweiss Financial Services, adjusted core CPI has been on continuous disinflationary path since June 2014. In fact, in 2016, while core CPI stopped disinflating owing to rise in petrol and diesel prices, adjusted core CPI continued to disinflate, touching a low of 3.7% in June 2017. However, in the past one year, this has risen sharply and is likely to touch ~5.7% in June.
Further, the increase in core CPI, though reasonably broad-based, is more pronounced in services compared to goods. This broad-based rise in core CPI has raised concerns amongst analysts and policymakers.
Here’s a list of indicators that surround near core CPI, as per Edelweiss.
Base effect: DeMon/GST de-stocking led to unusual decline in core CPI in the base period
While core CPI has been a relatively steady series, there has been a phase of unusual decline in the same. During the demonetisation and GST destocking phase (October 2016 to May/June 2017), the build up in adjusted core inflation was the lowest in many years.
Edelweiss said, “We think that as core inflation falls, the downward rigidity or stickiness will also increase i.e., it is relatively easier for core inflation to fall from 5% to 4%, but will take much more to push it further down to 3%. To that extent, we believe, a DeMon-like event (a massive monetary shock) would have significantly dented the pricing power of businesses, although temporarily.”
Rise in input prices also weighing on core CPI
The point-to-point increase in adjusted core CPI from October 2017-May 2018 is certainly on the higher side but that should not be so concerning.
According to Edelweiss, part of the rise reflects the effect of increase in input prices owing to rise in various commodity prices. This is clearly visible in some of the components such as transport & communication (ex-petrol and diesel) and household goods. Further, owing to GST implementation, service tax rate has increased and this may also have pushed up inflation in some of the segments such as recreation & amusement, among others.
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Typically, core inflation is defined as headline inflation excluding food and fuel. However, in India, commodities such as petrol, diesel, gold and silver are also part of core CPI. Further, in the past one year, housing inflation has been statistically inflated owing to implementation of governments’ 7th Pay Commission. Hence, the report analyzes adjusted core CPI (core CPI ex-commodities and housing).
