India's headline inflation may have reached the peak at 7.8%, with a little bit of luck, SBI Research says in its latest note. As per the government data released on Monday, the CPI inflation moderated to 7.04% in May 2022 from an 8-year high of 7.79% in April 2022.

Inflation in the food basket declined from 8.31% in April to 7.97% in May. Rural inflation eased to 7.01% from 8.38% the previous month, while urban inflation remained sticky at 7.08%. Core CPI also moderated in May to 6.09% as compared to 6.97% in Apr’22.

The deceleration in rural CPI is the major reason for the slowing of inflation in May. The rural CPI decelerated mainly on account of health, education and personal care and effects whose combined weighted contribution declined by 35 bps and food and beverages whose weighted contribution declined by 40 bps.

The SBI note says India's peak rate at the end of the cycle now has a “higher probability” of a lower bound of 5.5% and a lower probability of going up to 5.75%, depending on the inflation trajectory.

Its average inflation forecast for FY23 is 6.7%, which is the same projection as the RBI, though SBI's quarterly inflation numbers are slightly different. "The best thing is that the peak of inflation may have been reached at 7.8%, with a little bit of luck. The 10-year yield is also likely to be capped at 7.5%, assuming 5.5% as peak repo rate," says the SBI report.

On commentaries regarding the RBI being behind the curve in controlling inflation, SBI thinks it’s "much ahead of the curve” in controlling inflation and the Fed can borrow a template from RBI to control U.S. inflation. Notably, the U.S. inflation quickened to a 40-year-high of 8.6% in May, 1% up from April 2022, on high shelter, food and gas prices. The US inflation threatens to rip apart global financial stability, says SBI.

The economic research wing of India's largest bank says the invisible government hand behind controlling inflation must be appreciated, which has limited the pass-through by employing an activist fiscal policy.

"In fact, pass-through of energy inflation has been sharply higher in the U.S. also and in fact is higher than India. The interesting part is that energy and transport have a higher share in weighted contribution to overall inflation in the US when compared to India. In India, the share of energy in the weighted contribution of CPI inflation is 9.2%, while in the US it is 29.2%. For transport, it is 36.6% in the US compared to 10.3% in India."

As the global economy grapples with multi-decadal high inflation and slow growth, India's economy has gained momentum in the first two months of the financial year, which is evident in high frequency leading indicators, says SBI. The percentage of indicators showing acceleration (% yoy growth) has risen to 88% and 95% in April and May, respectively, in comparison to the 55-65% range in January to March, it says.

"Apart from other sectors, responding to the removal of restrictions, services sector regained momentum, which was echoed in high frequency leading indicators recording growth in most trade and transport sectors. Contact-intensive aviation and tourism sectors recorded sequential improvement, but the recovery remains lagged and will take time to recoup."

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