The Monetary Policy Committee (MPC) is due to announce its policy decision at its monetary policy review meeting scheduled for the end of September. We expect rates to rise again, following the cumulative 140 basis point (bps) rise seen since May 2022.
However, the quantum of the upside will likely be less than the 50 basis points seen in the last two meetings. We also see a low probability that the CPI inflation forecast for FY23 will be revised from 6.7%, and we strongly believe that the growth projection does not need to be lowered from the 7.2% current.
Since the last policy review, the big data release has been India’s GDP growth for the first quarter (April-June) of FY23. GDP expansion hit a four-quarter high of 13 .5% YoY (YOY) in the first quarter of FY23. This was helped by a weak base due to the second wave of Covid-19 in India in the first quarter of FY22, and a robust recovery in spending on contact-intensive services. While printing was broadly in line with our estimate, it was below the MPC’s projection of 16.2% for this quarter.
Despite the double-digit year-on-year expansion, real GDP exceeded pre-Covid levels in the first quarter of FY20 by only 3.8% in the first quarter of FY23. the trade, hospitality, transport, communications and broadcasting related services (THTCS) sector, the most affected segment during the pandemic, lagged 15.5% compared to the level of before Covid, reflecting the incomplete resumption of contact-intensive activities. services.
For the current quarter, the moderation in commodity prices from the highs seen in mid-June 2022 is positive for corporate margins and value added growth. However, high-frequency data for July-August 2022 confirms a much-expected slowdown in year-on-year growth in Q2 (July-September) FY23, compared to Q1 FY23, due to a normalizing base, in a context of uneven expansion from one sector to another.
In addition, risks from lower kharif production following delays in rice and pulse plantings, and weaker external demand, as evidenced by lower non-oil exports in August 2022, have emerged in the foreground.
Nonetheless, we expect 6.5-7.0% year-over-year GDP growth for Q2 FY23, above the current MPC projection of 6.2%, with an upside stemming from continued the recovery in demand for services and the correction in the prices of the main commodities.
Additionally, we expect higher growth in the second half (October-March) of FY23 of 5.0-5.5% versus the MPC projection of 4.0%, partly based on our view that public and private investment will be halted. Therefore, we continue to expect GDP to grow by 7.2% in FY23 and see no case for a downward revision to the MPC projections.
While CPI inflation had cooled to 6.7% in July 2022 from an average of 7.3% in the first quarter of fiscal 2023, we expect a base effect-induced rise at 6.9-7.0% in Aug-Sept 2022. This implies an average CPI inflation print of 6.9% in Q2FY2023, slightly below the MPC projection of 7.1% for this trimester.
The correction in commodity prices bodes well for easing pressures on domestic input costs and core CPI inflation in the near term. In particular, crude oil prices fell significantly, although this did not translate into a change in retail fuel prices. Regardless, we remain cautious about the sustainability of these levels as we approach Northern Hemisphere winter.
In our view, the strong domestic demand for services remains a key element to watch, given its large share in the CPI basket (services: +23.4%). In addition, the delay in sowing the kharif is a concern, which recently resulted in a 20% export duty on various grades of non-basmati rice.
Overall, we expect CPI inflation to follow the MPC projections for the third quarter (October-December) for fiscal year 2023 of 6.4%, based on our lower printing projections. to 6% in November 2022 and December 2022. For the fourth quarter (January-March) FY23, our forecast is similar to that of the MPC, which informs our average forecast for CPI inflation of 6.5% for FY2023.
However, we think the MPC is likely to err on the side of caution, given the upside risks to food and services in the CPI basket, and maintain its CPI inflation forecast. base at 6.7%.
Given the MPC’s emphasis on anchoring inflation expectations during its August 2022 policy meeting and comments by the RBI Governor aimed at ensuring that CPI inflation moves closer to the target of 4.0% over the medium term, we believe rate hikes will continue until it is likely that CPI inflation readings will fall below 6%.
However, with the underestimation of growth relative to the MPC projections for Q1 FY23 and the likelihood of CPI inflation printing slightly lower than expected for Q2 FY23, we expect the MPC tempers the quantum of the rate hike to 35 basis points in its September report. 2022 meeting of 50bps in its last two meetings. Finally, merchandise trade deficit prints for July and August have increased from average monthly levels seen in the first quarter of FY23, and India’s current account (CAD) deficit is expected to widen further for reach 5.0% of GDP in the second quarter of FY23. compared to the 3.6% expected in the first quarter of FY23.
Against this backdrop, the RBI Governor’s comments regarding the external sector would be closely watched, following assurances at the previous meeting that the CAD should remain within manageable bounds.
Recent comments from the RBI regarding preventing excessive volatility and anchoring expectations around INR depreciation suggest that the Rupee is likely to trade in a relatively narrow band in the near term. With REIT stock inflows picking up, we expect INR to trade between 78.5-81.0/$ in the rest of CY22 amid global headwinds
The author is Chief Economist at ICRA Limited
September 11, 2022