India’s inflation seems to have peaked and will moderate but is still at uncomfortably high levels, Reserve Bank of India Governor Shaktikanta Das said.

Sustained high inflation could harm growth in the medium term, he added.

The RBI has retained its retail inflation forecast at 6.7% for current fiscal, still higher than its target band of 2-6%. The central bank is banking on a normal monsoon and tempered  crude oil prices when it is keeping its forecast on inflation unchanged.

Das said inflation in second and third quarter of the current fiscal is expected to remain above the upper tolerance limit of 6%. Inflation projection in Q2 is at 7.1%, Q3 at 6.4% and Q4 at 5.8%, with risks evenly balanced. For Q1 of 2023-24, the RBI has projected inflation at 5%.

In its earlier June policy, the RBI had projected retail inflation for 2022-23 at 6.7%, up from its 5.7% forecast in April.

Retail inflation, based on the Consumer Price Index (CPI), which RBI factors in while fixing its benchmark rate, stood at 7.01 % in June. Inflation has been ruling above the RBI's comfort level of 6 % since January earlier this year

The RBI on Friday raised the benchmark lending repo rate by 50 basis points to 5.40%.

Inflation in India is “primarily due to supply issues and imported inflation,” Das reiterated. “The Indian economy has been impacted by the global economic situation. We have been grappling with high inflation and financial markets have been volatile,” he added.

Inflation based on wholesale price index (WPI) remained in double-digit for 15 months in a row. The WPI reading was at 15.18% in June.

GDP growth

On GDP growth, the RBI has also kept its projections unchanged at 7.2% for  2022-23.

The central bank in April slashed the GDP growth projection for 2022-23 to 7.2% from its earlier forecast of 7.8%.

Despite the repeated assurances of positive growth impulses by the central bank, the financial markets have remained uneasy, with intermittent corrections.  India saw large portfolio outflows to the tune of $13.3 billion during the current financial year so far (up to 3 August). 

“Nevertheless, with strong and resilient fundamentals, India is expected to be amongst the fastest-growing economies during 2022-23 according to the IMF, with signs of inflation moderating over the course of the year,” Das said.

The RBI expects growth in the first quarter of the current fiscal at 16.2%, which will taper to 4% by the fourth quarter.

“The RBI delivered a textbook policy announcement today – one that is frontloaded and aggressive in response to inflation that remains high while the growth momentum remains reasonably positive,” Abheek Barua, chief economist at HDFC Bank, said. 

Barua expects the rates to be hiked by another 25 basis points by the end of the year. “We expect the RBI to continue with its rate hikes in the upcoming policies taking rates up to 5.75% by the end of the year. The bond market rally seen over the last few days is likely to reverse and we expect the 10-year paper to trade closer to 7.3-7.4% by the end of the quarter as markets reprice in RBI action and the supply of both SDL and central government bonds this year,” he said.

Liquidity

Overall, system liquidity continued in surplus, with average daily absorption under the liquidity adjustment facility (LAF) at Rs 3.8 lakh crore during June-July. Money supply (M3) and bank credit from commercial banks rose (y-o-y) by 7.9% and 14%, respectively, as on 15 July. India’s foreign exchange reserves were placed at $573.9 billion as on 29 July.

RBI said it  will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted – both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors, depending on the evolving liquidity and financial conditions.

This will help the economy in emerging out of the shadows of the pandemic and the impact of the war in Europe. While the banking system remains well capitalised and profitable, a deleveraged corporate sector augurs well for sustaining the recovery, RBI said in its report.

Surplus liquidity in the banking system, as reflected in average daily absorptions under the LAF (both SDF and variable rate reverse repo auctions), moderated to Rs 3.8 lakh crore during June-July 2022 from Rs 6.7 lakh crore during April-May. The sharp moderation in surplus liquidity from 20 July, mainly on account of tax and capital outflows, resulted in money market rates firming up above the repo rate. 

To alleviate the liquidity stress, the RBI conducted a variable rate repo auction of Rs 50,000 crore of three days maturity on 26 July.