Risks to inflation outlook up; RBI ability to hold on to accommodative stance to face challenge: Sonal Varma, Nomura

“The government may not immediately cut excise duty given that they just announced the cut in November. We are yet to start in FY23 and there are still a lot of uncertainties and while a reduction in excise duty will protect consumers, that will also mean some compromises. The government will have to work on its capex plans, which it may not want to do right now. It is a risk to the fiscal math,” says Sonal Varma, MD & Chief Economist, Nomura.

The big problem for India is crude oil prices. There is already conversation about how in the next couple of days, crude oil prices could reach triple digits. It could go to $100, beyond $100 and that is just going to throw the fiscal math out of the equation, when it comes to India.
This is actually going to be quite tricky for the government. Whether this throws the fiscal math out of order really depends on whether the government decides to shield the consumer. Since November, fuel prices have not been adjusted yet. So some sort of an adjustment is likely after the state elections in March.

Our sense is the government may not immediately cut excise duty given that they just announced the cut in November. We are yet to start in FY23 and there are still a lot of uncertainties and while a reduction in excise duty will protect consumers, that will also mean some compromises. The government will have to work on its capex plans, which it may not want to do right now. It is a risk to the fiscal math. At this stage, our view is potentially the consumer will have to bear the higher prices.

The other flash point – and it could be a double whammy of sorts – is that crude is on the boil and what is happening on Mint Street.
Yes that is right. First of all, there is a lot of uncertainty in terms of the overall geopolitical situation and the combination of higher energy prices plus tightening financial conditions is sort of a stagflationary shock for the net commodity importer like India. So it does make the trade off between growth and inflation even harder to manage.

Now we did get a surprise dovish hold from the RBI at the February meeting and the bigger surprise actually was the RBI’s inflation projection where they see inflation averaging 4.5% in FY23. Our own view is there are lots of pipeline price pressures. Oil price of course is one of them and that is going to move up but there are clearly spill-overs of oil on to a lot of other broader commodities in terms of higher gas prices, transportation cost going up.

There has been an increase in commodity prices even outside of oil and so there were a lot of input cost push, inflationary pressures and India is also seeing a pretty smart rebound from the third wave. So, service reopening is also going to put an upside pressure on inflation. So while we have got a dovish hold from the RBI, from our standpoint, risks to the inflation outlook are to the upside and therefore the ability to hold on to the accommodative stance for very long will come under challenge.

RBI will have to move away from its growth focus to try and battle inflation and we actually see a rate hike come in?
It is a pretty challenging situation. At the end of the day, the question is to what extent, easy monetary policy is helping growth on a durable basis? The big risk for India, of course, is that continued tolerance of high inflation leads to expectations moving higher and one thing we have seen even prior to the third wave is demand in the mass consumption segment weakening, which partly is because of less savings and weaker income growth.

It is also because of the inflationary pressures. If inflation continues to move up and becomes more entrenched, then there will also be a negative impact on real consumer incomes. It can impact corporate profitability as well. It is a fine balance and at the margin, the role for monetary policy actually is lesser primarily because the concerns around inflation are rising.