Brokerages say the recent surge in inflation is largely transient and is unlikely to prompt the Reserve Bank of India (RBI) to raise rates immediately, even as a hike is being talked about in some sections after retail inflation spiked to a 15-month high in July.

Kotak Institutional Equities, Morgan Stanely, ICICI Securities and Nomura Research foresee a prolonged pause by the RBI and average consumer price inflation (CPI) inflation at around 5.6 percent in the current fiscal.

The headline retail inflation in July shot up to 7.44 percent, pushed up by a spike in vegetable prices, especially that of tomatoes. The print was way above the RBI’s upper tolerance range of 2-6 percent.

Incremental CRR to be extended?

Nomura said while there was an increase in inflation due to rising food prices, there were indications that core inflation, the non-food-non-fuel measure of inflation, was showing signs of easing.

Instead of a rate hike, the brokerage house expects the central bank to temporarily extend incremental cash reserve ratio (CRR) or employ alternative methods to tighten liquidity.

In its August review, the RBI’s monetary policy committee (MPC) held rates steady at 6.5 percent as it did in the previous two meetings of the current financial year after raising the repo rate by 250 basis points since May 2022 to fight inflation.

One bps is one-hundredth of a percentage point.

The MPC, however, asked banks to maintain a 10 percent incremental CRR to drain excess liquidity from the system following the withdrawal of Rs 2,000 notes. The move, up for review on September 8, would suck over one trillion rupees from the banking system, the RBI said.

According to analysts, supply-side measures are essential to cool vegetable prices. Recent steps taken by the government have proven effective in curbing vegetable inflation in August. The introduction of the incremental cash reserve ratio is another temporary strategy aimed at reducing liquidity in the market, they said.

Analysts expect inflation to start moderating below 6 percent from November.

Expert take

Kotak Institutional Equities said the recent increase in headline inflation may lead markets to reconsider MPC’s capacity to overlook these effects. But despite ongoing uncertainty due to adverse weather events, the July upswing would be temporary, its analysts said in a note. This is because supply chains are anticipated to readjust in the forthcoming months, supported by both the increase in kharif sowing and supply-side interventions by the government.

The measures “… should suffice to gradually rein-in vegetable inflation, thereby wrestling headline inflation down below 6 % YoY by Sep’23. We do not believe any further action on the policy rate is needed in CY23 and retain our call that the next move will be a 25bp rate cut in Apr ’24 “, ICICI Securities said.

Morgan Stanley expects inflation print to be above 7 percent in August and revert to around 6.5-7 percent in September and October.

It expects core inflation to remain steady at 5-5.2 percent and the RBI to delay the start of the easing cycle to the second quarter of 2024 instead of the first quarter.

“We maintain our expectation of two rate cuts of 25bps each,” it said. In the near term, the brokerage expects RBI to maintain focus on liquidity management to ensure it remains close to neutral and the interbank weighted average call rate remains at or a tad above the repo rate.

“As such we see a high probability that RBI may continue with the incremental CRR announced on August 10, which is expected to be reviewed on September 8,” Morgan Stanley analysts said in a report.