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The Reserve Bank of India (RBI) could be pushed towards raising the policy repo rate from the current 5.25 per cent to around 6.5 per cent as accelerating retail and wholesale inflation increases the risk of negative real interest rates, according to a report by Systematix Institutional Equities.
The report said inflationary pressures are becoming increasingly broad-based, with headline Consumer Price Index (CPI) inflation rising to 4.82 per cent in August from 4.45 per cent in July. This marked the third consecutive month that inflation remained above the RBI's 4 per cent target midpoint. Food inflation climbed to 5.95 per cent, while rural inflation at 5.23 per cent remained higher than urban inflation of 4.31 per cent. "The RBI's current position of keep rate at 5.25% as long as possible looks increasingly out of step with the inflation trajectory WPI persistently high, CPI nearing 5% and a projected climb toward 6% all point to growing discomfort with negative real rates scenario," the report said. Wholesale inflation is adding to the pressure, with WPI rising to 9.92 per cent in August from 9.78 per cent in July. Fuel inflation surged to 22.93 per cent from 20.05 per cent, while inflation in manufactured products stood at 8.37 per cent, food prices at 7.05 per cent and primary articles at 7.76 per cent. Systematix said food remains the dominant source of price pressure, particularly certain vegetables and spices. Elevated fuel and energy costs linked to global factors, including developments in West Asia, along with higher manufacturing and input costs, are widening inflationary pressures. Core inflation also edged up to 4.2 per cent. The brokerage expects inflation to continue rising and potentially cross 6 per cent by October-November, citing the feedback from elevated wholesale inflation, El Nino-related risks to food supplies and persistently high crude oil prices. It said the wide gap between WPI at around 9.9 per cent and CPI at 4.8 per cent indicates that companies have so far been absorbing a significant part of the increase in input costs. "Inflation is expected to sustain its rise, potentially crossing 6% by October-November, driven by the feedback loop from elevated WPI inflation," the report said. The pressure on corporate costs is already visible in manufacturing, according to the report. Interim first-quarter FY27 results showed manufacturing-sector sales growing 25.6 per cent year-on-year, while raw material costs jumped 40 per cent. As a result, value addition declined 4.5 per cent in nominal terms and the raw material-to-sales ratio rose by more than eight percentage points to 75.3 per cent, pointing to the likelihood of pipeline inflation. Against this backdrop, Systematix sees a strong case for monetary tightening. It said a real interest rate of at least 1 per cent would imply a nominal repo rate closer to 6.5 per cent. Prolonged negative or near-zero real rates could encourage leveraged consumption, weaken savings and leave the central bank with less room to respond if inflation becomes more generalised. "We expect a shift toward a meaningfully positive real rate, with the repo nearer 6.5%, rather than continued accommodation. Watch the early-October MPC meeting for the first signs of that pivot," the report said. The report also warned that sustained inflation, at a time when household wage and income growth remains muted, could accentuate stagflationary pressures. On financial markets, it expects a potential rise in the repo rate to 6.5 per cent to push the risk-free rate higher, with the 10-year bond yield moving towards 7.45-7.50 per cent, raising the cost of capital and keeping pressure on valuations. (ANI)
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