RBI flags upside risks to inflation.

Outlook raises possibility of another rate hike, say experts The Reserve Bank of India (RBI) on Wednesday reiterated concerns over rising inflationary pressures this fiscal year due to global and domestic pressures and called for continuous vigil to keep them at bay.

“Headline inflation, which averaged 4.8% during Q1 FY19, is likely to face upside risks over the rest of the year from a number of sources, warranting continuous vigil and a readiness to head off those pressures from getting generalized,” RBI said in its 2017-18 annual report.

It pointed out that rising global commodity prices, especially of crude oil, and recent global financial market developments are firming up input cost pressures.

Staggered impact of revisions in house rent allowance by various state governments could also pose an upside risk through second round effects, the central bank said. “Much will depend on how food prices play out and how effective are the supply management strategies,” it said.

The central bank projects headline inflation at 4.6% in Q2FY19; 4.8% in H2 and 5% in Q1 FY20, including the HRA impact for central government employees. But, excluding the impact of HRA revisions, headline inflation is forecast at 4.4% in Q2FY19; 4.7-4.8% in H2 and 5% in Q1 FY20.

Some experts believe RBI’s hawkish tone heightens the probability of another policy rate hike.

Gaurav Dua, head of research, Sharekhan by BNP Paribas said RBI appears sanguine about growth with pick-up in manufacturing and turnaround in capital formation along with strong agriculture output for the third consecutive year.

“Given the improving growth outlook and inflationary concerns, RBI is expected to toe the hawkish line and probability of another rate hike remains high,” said Dua.

Since the start of this year, RBI has raised the key repo rate by 50 basis points to 6.5% currently.

The global economy expanded at a strong pace in the first half of 2018. While activity was accompanied by tightening labour markets, firm commodity prices and resilient trade dynamics in advanced economies, the emerging markets front-ran the advanced economies in Q1 but trailed somewhat in Q2.

This, RBI said, was owing to the exit of capital flows on risk aversion generated by a “cocktail of trade wars, rising interest rates in the US, geo-political tensions and the unrelenting hardening of crude oil prices.

It added that headwinds could nonetheless rise from further tightening of financial conditions, escalation of trade tensions and intensification of geopolitical risks.

Other economists are of the opinion that since RBI is mandated to target the headline inflation as measured by the consumer price index (CPI), a rate hike is not expected.

“The central bank is mandated to maintain headline inflation at 4% (+/- 2%) in its inflation targeting regime. While the core inflation has been hardening and will likely average around 5.7-5.8% levels in FY19, the softer food inflation is expected to offset the pressures on headline CPI. As such we expect headline CPI to average closer to 4.5% in FY19,” said Shubhada Rao, chief economist at Yes Bank.

Rao explained that the impact on the economy of two back to back rate hikes in June and August will play out over two quarters. “However, in an environment of heightened global volatility, with hardening crude prices, sustained strength in the US dollar, trade wars among others, the central bank continues to remain data-dependent for reviewing the policy stance,” she added.

However, the central bank expects an acceleration of activity in the Indian economy. For instance, the initial lull in the progress of the south-west monsoon got reversed, cropping gaps are closing and agricultural production is likely to remain strong for the third consecutive year.

On the industrial front, there has been a sustained pick-up in manufacturing and mining activity, especially coal and corporates are reporting robust sales growth and improvement in profitability as pricing power returns.

“Keeping in view the evolving economic conditions, real GDP growth for 2018-19 is expected to increase to 7.4% from 6.7% in the previous year, with risks evenly balanced,” RBI said. (Source: Livemint)