By Indranil Sen Gupta & Aastha Gudwani
We continue to expect RBI MPC to cut rates 75bps by October although June CPI inflation, at 6.1% today, came in slightly above its 2-6% mandate.
Inflation is still peaking off from 7.2% in April. Second, supply disruptions, due to the national lockdown, are raising prices temporarily. (We track July inflation at 6.4% on a tomato price spike due to similar issues.) Finally, we see CPI inflation slipping to 2.5% in H2FY21 on base effects, good rains (Met forecasts 102% of normal), low demand and tight liquidity. On balance, we expect RBI MPC to cut rates by 25bps on August 6 and 50bps in October. Second, to contain yields in face of a 10.7% of GDP of consolidated fiscal deficit, RBI will likely conduct OMO for $102bn. Finally, it should extend the HTM facility to incentivise banks to buy G-secs.
Inflation: 6.1% June, 6.4% July, 5.1% core, 2.5% H2FY21
June CPI inflation moderated to 6.1% from 6.3% in May and 7.2% in April. This was higher than our (5.4%) and consensus forecasts (5.3%) as the imputation methodology inflated CPI number. While food inflation softened, rising oil taxes pushed up fuel price inflation. Higher gold prices potentially pushed personal care price inflation to double digit levels. In the absence of item-wise data, we can only compute core as headline excluding food, fuel and transport & communication. This inched up to 5.1% in June from 4.6% in April- May (see graphic). Rising tomato prices will likely push July inflation up to 6.4%. That said, we see inflation falling to 2.5% in H2FY21 on base effects, as H2FY20 CPI inflation rose to 6.3% from 3.2% in June 2019.
RBI cuts: 25bps Aug 6, 75bps by Oct; 200bps if 7.5% GDP fall
We expect the RBI MPC to cut rates by 25bps on August 6 and 50bps in October to combat the Covid-19 shock. With inflation breaching his 2-6% inflation mandate, Governor Das will likely want to see remission before a bigger 50bps cut. This assumes our base case of GDP contracting by 4% with the lockdown stretching to mid-September and the restart taking all of October. If the world economy has to wait for a vaccine, FY21 GDP will likely contract by 7.5%. In such a case, RBI will likely cut another 200bps in FY21.
Fundamental drivers of inflation remain weak
GDP contraction: We expect FY21 GDP to contract by 4%. BofA India Activity Indicator also points to a large-scale contraction in June. If the world economy has to wait for a vaccine, India’s GDP will fall 7.5%.
Tight M3 liquidity: We see marginally excess M3 demand.
Good rains to contain agflation: The south-west monsoon, at 13.4% of normal, is progressing steadily. This has pushed sowing up to 44% y-o-y, with 55% of total area under kharif crop sown.
Low ‘imported’ inflation: Our oil strategists see dated Brent price at $443.7 in 2020 (vs $60/bbl in FY20). RBI’s $45bn FX intervention (BofAe, $25bn done so far) should contain depreciation.
Fiscal slippage unlikely to be inflationary given falling growth: We see the Centre’s fiscal deficit target at 6.85% of GDP for FY21 BofAe, 335bps higher than target. While this is above the 4.5% long-run average, growth is 11+% below potential.
Edited excerpts from BofaML’s India’s Economic Watch (dated July 14)
Sen Gupta is chief India economist and Gudwani is India economist at BofA Merrill Lynch. Views are personal