It could take at least another one-and-a-half years for India's headline retail inflation rate to return to the Reserve Bank of India's (RBI) medium-term target of 4 percent, according to Sonal Varma, Nomura's chief economist for India and Asia (excluding Japan).
"Most of our forecasts are for until December 2023. And during that horizon, we don't have inflation getting back to 4 percent," Varma told Moneycontrol in an interview.
Data released on August 12 showed Consumer Price Index (CPI) inflation slipped to an expected five-month low of 6.71 percent in July—the 34th straight month in which it had come in above 4 percent. If it remains above 4 percent through the remainder of 2022 and all of 2023, it would be above 4 percent for 51 consecutive months.
The last time CPI inflation was below 4 percent was in September 2019, when it had come in at 3.99 percent.
The RBI currently sees CPI inflation averaging 6.7 percent in FY23, with the most forward-looking forecast being 5 percent for April-June 2023. But even before that, the Indian central bank will likely have to admit that it has failed to meet its inflation mandate.
With CPI inflation having averaged 6.3 percent in January-March and 7.3 percent in April-June, the RBI will fail to meet its mandate if the average for July-September is outside the 2-6 percent tolerance range. Such an outcome is likely as the RBI itself has forecast inflation will average 7.1 percent in the current quarter.
According to Varma, the RBI failing would not be extraordinary as most central banks are missing their inflation targets on account of global commodity price pressures and the supply-side bottlenecks that have wreaked havoc following the onset of the pandemic over two years ago.
"What is important is the central bank's response. Until April, the RBI did nothing. But there has been a change since then in terms of communication and follow-up with monetary policy action. Even the August policy decision to hike the repo rate by 50 basis points came with a fairly open-ended forward guidance and there is no pre-commitment to any sort of pause," Varma said.
Terminal and beyond
In an effort to bring down inflation, the RBI's Monetary Policy Committee (MPC) has increased the repo rate by 140 basis points in the last three-and-a-half months. And Varma thinks the central bank is not done yet, with another 60 basis points worth of rate hikes pencilled in for the next two meetings, which would take the repo rate to 6 percent by the end of 2022. Following that, the RBI is seen staying pat through 2023.
"Once the repo rate reaches around 6 percent, a forward-looking assessment needs to be done about what inflation and the macro outlook will be like 6-12 months down the line," Varma said.
In addition to commodity prices, the other potential disinflationary force is a weak outlook for growth. This could allow the MPC to not raise the repo rate higher than 6 percent.
"We expect a synchronised global downturn. Historically, that has resulted in slower growth in India, but with a lag. So while there is sufficient momentum in India's domestic demand right now, the lagged effects of lower input cost pressure and weaker growth means there should be a moderation in inflationary pressures going forward," Varma said.
Nomura sees India's GDP growth tapering off sharply to 5.5 percent in FY24 from 7 percent in FY23.
The rapid tightening of monetary policy in advanced economies is expected to push them into recession, with the US already in a so-called technical recession after its GDP contracted by 1.6 percent in January-March and 0.9 percent in April-June.
Closer home in Asia, China's economic slowdown is already ringing alarm bells. On August 15, the People's Bank of China cut interest rates by 10 basis points after weaker-than-expected industrial growth and retail sales, while home prices fell for the 11th month running in July.
If there is no US-led global recession and commodity prices increase, Varma expects the repo rate to be higher than 6 percent as inflation would be quite sticky and must start moving towards 4 percent as just bringing it under 6 percent is "not good enough".
"One must also consider how soon the MPC wants to return inflation not just to the target range but to the 4 percent midpoint. We are assuming the MPC will be OK with underlying inflation of above 5 percent but less than 6 percent. If the objective is to get to 4 percent in FY24, then the terminal repo rate will have to be much higher than 6 percent," Varma said.
Capex delay
As a result of an expected synchronised global downturn, Varma thinks the outlook for India's exports and investments over the next 12-18 months is relatively weak.
"Historically, what we have found is that the export and investment cycles tend to move in tandem. And when you have weaker external demand, production takes a hit and capacity utilisation comes down. So fixed investments also tend to slow down."
The central government has focused on capital expenditure to revive India's growth in the post-pandemic era, with the budget target for FY23 set at a record Rs 7.5 lakh crore, which includes Rs 1 lakh crore for states as an interest-free, 50-year loan.
In its most recent monthly economic report, released on July 14, the finance ministry said the Centre's capex focus may have begun to crowd in private investment. Meanwhile, the MPC had said in its August 5 statement that the government's capex push and increase in capacity utilisation should support investment activity.
As per an RBI survey, capacity utilisation in the manufacturing sector rose to 75.3 percent in January-March—the highest in three years.
However, Varma is yet to see any durable signs of a turnaround in capital expenditure as a whole. Further, if export demand does slow down, capacity utilisation could decline in the second half of FY23 and in FY24.
"Ultimately, the decision to invest is driven by demand-side factors. And given the risks to global growth, we think the timeline for the capex cycle turning around will get pushed out even further. At this stage, we don't see the manufacturing capex cycle moving up. Therefore, the heavy lifting will have to be done by the government in terms of the infrastructure build to push on the capex front," Varma said.
Even as India's growth rate is expected to fall next year, the challenge is primarily cyclical. Further, Varma expects the extent of the slowdown to be less compared with other Asian countries that are more open, export-driven and exposed to the semiconductor cycle.