India: Inflation not a cause for concern, currency is the big unknown - Nomura

RBI’s October policy meeting comes on the back of two consecutive hikes of 50bp cumulatively, reflecting demand-driven pressures and sticky inflationary expectations, according to analysts at Nomura.

Key Quotes

“The slowdown in inflation driven by exceptionally low food prices, the favourable base, expectations of slowing growth and the settling down of core momentum – make the case for a long policy pause. However the recent rupee depreciation to record lows, combined with escalating oil prices has thrown a spanner in the works in these dynamics and has caused an increase in expectations of the RBI to raise interest rates in defence of the currency.”

“We have argued in the past that because of the RBI’s inflation-targeting mandate, any rate reaction will depend on the spill-over of currency depreciation on inflation. Because of the RBI’s estimate of the 15-20bp inflationary impact for every 5% of depreciation, we do not see significant bloating of inflation from the ~6% incremental depreciation since the August policy review.”

“We attach a 60% probability to no change at the October policy review and a 40% probability of a further 25bp rate hike (up from 35% earlier) mainly owing to pressure from currency weakness and higher oil prices. However, inflation does not warrant a hike in our view.”