Risks to inflation have risen, but growth could still hold on to 7.2% was the message from the June monetary policy meet. Over the past four months, the Reserve Bank of India (RBI) has revised up its inflation forecast by 220 basis points (bps) to 6.7% for fiscal 2023.

Rising risks to inflation translated into the RBI ramping up its fight against it by fast forwarding the rate hikes. The May 4 rate hike of 40 bps was a surprise and bond markets reacted adversely. This also tightened domestic financial conditions in May (CRISIL Financial Conditions Index). The RBI’s repo-rate hike triggered a sharp rise in rates in the money and bond markets, while tightening global conditions increased foreign investment outflows and the rupee’s depreciation.

While the 50 bps rate hike on June 5 was factored in by the markets, the slipover of global tightening conditions on India has continued in June. After printing 7.8% in April, consumer inflation came down to 7% in May. This does not offer much comfort and cannot be taken as a sign of peaking out of inflation for two reasons. One, a high base of last year was the key reason for this decline. Second, the WPI inflation increased to 15.9% in May over a high base of last year. The WPI can be taken as proxy for input costs, which have risen sharply but have only been partly passed through to Consumer Price Index (CPI) due to uneven demand. The rising Wholesale Price Index (WPI) will maintain the upward pressure on CPI.

CRISIL projects the average inflation for the current fiscal at 6.8%, with inflation nudging below 6% only by the last quarter. We also expect the RBI to raise repo rates by at least 75 bps this year. In addition to domestic inflation, rate hikes are necessitated by the aggressive stance of the United States (US) Federal Reserve and tightening global financial conditions. The Fed raised rates by 75 bps on June 15.

We retain our growth outlook at 7.3% for the current fiscal with the risks tilted to the downside. We believe the peak impact of monetary tightening will be felt towards the end of this fiscal and a rebound in contact-based services will, to some extent, offset the headwinds from higher crude prices and slowing global growth. Our outlook also assumes that despite the flare-up in the number of Covid-19 cases, the pandemic will not disrupt economic activity materially. Finally, normal monsoons, if well distributed, should support agricultural activity this fiscal. We keep our fingers crossed on the impact of freak weather on agriculture.