With the recent announcement of an average 6% MSP (minimum support prices) hike for the kharif crops, there will be an upside pressure of 15 to 20 basis points on inflation, says SBI Research in its latest note. The PM-led Cabinet on June 8 had approved the MSP hike for paddy, and 15 other mandated kharif crops by up to ₹523 for 2022-23.

The SBI report, which comes after the RBI's MPC announcement to hike the key repo rate by 50 bps to 4.90%, says the central bank is expected to factor in a rate hike in August and October policy announcements as well. It may be aiming at taking the repo rate higher than the pre-pandemic level by August to 5.25% and in October to 5.5%, the note, written by SBI Group chief economic adviser Soumya Kanti Ghosh says.

"Our peak rate at the end of the cycle now has now a lower bound of 5.5% and could go up to 5.75% depending on inflation trajectory. This is purely data-dependent and subject to revisions," says Ghosh.

As per the market expectations, RBI’s MPC unanimously decided to hike the policy repo rate, remaining focused on ‘withdrawal of accommodation’ to keep spiralling inflation within its tolerance target and support growth.

The RBI retained its real GDP growth forecast for FY23 at 7.2%, with risks broadly balanced. However, inflation projections for FY23 were revised upwards by 100 bps to 6.7%. The RBI cited factors like tense global geopolitical situation, elevated commodity prices, adverse global supply conditions and high crude oil prices.

The RBI governor, in his MPC announcement address, alluded to the proactive role fiscal policy can also play with monetary policy to control inflation. "This could be achieved with state cutting VAT on fuel as a policy option to anchor inflationary expectations. Interestingly, economic literature suggests that a monetary policy contraction accompanied with fiscal policy expansion is the ideal coordinated policy outcome with the maximum payoff," says the report.

The MPC policy flags the global uncertainty, with many countries grappling with multi-decadal high inflation and slowing growth, persisting geopolitical tensions and sanctions, elevated prices of crude oil and other commodities and lingering Covid-19-related supply-chain bottlenecks.

The World Bank in its recent assessment says the global economy could slump from 5.7% in 2021 to 2.9% in 2022 — significantly lower than the 4.1% anticipated in January. India's growth forecast for FY22 is pegged at 7.5% in 2022-23, a downward revision from the 8% predicted earlier.

Among all the factors at play, the Russia-Ukraine war has played a bigger role in magnifying the situation. "Russian invasion of Ukraine has magnified the slowdown in the global economy, which is entering what could become a protracted period of feeble growth and elevated inflation," says the SBI note.

Amid global uncertainties, growth numbers continue to show optimism locally, says Ghosh. "Capacity utilisation rates have now moved up to 74.5%, with new investment announcements at a record high of Rs 20 lakh crore in FY22 and manufacturing sector leading from the front. This will give more comfort to RBI in pushing through the rate hikes and controlling inflation as its primary and foremost option."

Also, SBI researchers think 10-year benchmark yields are likely to be capped at 7.5%, even assuming a 175 basis point spread over its peak repo rate at 5.75%. "This is because, the term premium is likely to be 50 basis points, factoring in a further market adjustment of 50 basis points over and above 5.75% as an insurance rate hike and an additional 75 basis points because of supply overhang. This makes the total spread of 175 basis points over 5.75%." Interestingly, the pre-pandemic spread was around 135 basis points.

Moreover, the hike in repo rate is expected to curtail inflation through the credit channel as well. "As every 1 bps increase in repo has a combined impact of Rs 305 crore on-demand from retail & MSME consumers, with terminal repo rate at 5.75%, there will be a reduction in demand from consumers to the tune of Rs 45,000 crore."

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