Probability of back-to-back rate hike up; Re may not breach 79 in a hurry: Aditi Nayar

“A combination of higher prices is creating more sensitivity for diesel as well as the rail freight. The meaningful changes that were made by the Indian Railways over the last couple of years to divert a lot of freight to the rail sector from diesel demand is yielding fruit,” says Aditi Nayar, Chief Economist, ICRA.

While the April data is quite robust at 115 levels. Is it safe to say that we are trending higher than the pre-COvid levels? What is your assessment of the economic situation?
The business activity monitor stood at a very healthy level of 115.7 in April 2022. This is the second highest level in the last 13 months. So this is a very important factor. Normally we see activity dipping in April compared to March in every fiscal year. But this time, the dip has been very small and therefore we are at the second highest level in 13 months.

Also the year-on-year (YoY) growth is very high because we are on the low base of the second wave in April 2021; however, when we compare it to the pre-Covid level we got almost a 16% growth in the activity levels in April 2022 and this is quite meaningful. Especially when we look at the sectors which are growing over pre-Covid levels versus a narrower set which is showing a contraction in activity compared to April 2019.

Now the focus is on how to tackle inflation. This is something which was known earlier, but most of the central bankers across the world have just started to take a note and act against it now?
Sectors which are doing rapidly better include the GST E-Way bill and this is an indicator which tells us how goods are moving across the country. It is quite a meaningful indicator in terms of giving us a sense of how things are recovering and the sense we are getting from the GST E-Way bill data is very much corroborated by rail freight as well as the cargo traffic data.

As a result of the higher commodity prices the value addition in terms of non-oil exports growth is also very high. Similarly petrol consumption, electricity generation, Coal India’s output – all these indicators are pointing to a much higher level of activity in April 2022, compared to April 2019. However, in that month we still had some lag as far as auto output is concerned and that is more because of the supply side issues and less because of pure demand conditions and the contact intensive sectors, particularly airline passenger traffic, still showing some lag as compared to the pre-Covid level.

But we have seen that the lag is compressing quite rapidly in the last couple of months. Lastly, one of the lagging indicators is diesel consumption that is partly because of the hike in prices but also because there has been a lot of divergence in rail freight. It is reflecting the fact that demand has shifted on a certain set of routes and certain distances from the road sector to the rail sector.

How is the data trending for the month of May, especially in some high frequency indicators like electricity consumption? Our channel checks were suggesting that there is some tapering down as far as demand of electricity is concerned. What are your channel checks suggesting?
In May, the early indications are quite positive. We have got a good number of vehicle registrations for the early part of the month and clearly this is an indicator which peaks at the end of every month. So, the early signs are quite encouraging. Also electricity demand growth has surged in March although that is partly because it is terribly hot in the north and central India and petrol consumption on all counts whether we look at YoY, month on month or in comparison with pre-Covid petrol consumption is growing very rapidly and far outstripping what we are seeing on the diesel side.

So again, a combination of higher prices is creating more sensitivity for diesel as well as the rail freight. The meaningful changes that were made by the Indian Railways over the last couple of years to divert a lot of freight to the rail sector from diesel demand is yielding fruit.

What would be your view on WPI? When do you see it tapering considering it has been in double digits for long?
This remains an area that we need to watch very closely and although there has been some correction in commodity prices in May, after the lockdowns in China and the slowdown in economic activity over there, it may not really be enough to meaningfully bring down the WPI inflation in the immediate term, at least until the Russia- Ukraine conflict continues.

Going ahead, our view is that after seeing WPI inflation data, the probability of a back to back rate hike in the June policy review has only gone up and we are pencilling in a 40 bps increase in the repo rate in the June 2022 policy and another 35 bps in the August 2022 policy. After that we expect there will be some pause to really look at the impact on growth and our terminal rate expectation is 5.5%.

We do not believe that in the current situation where the drivers of inflation are primarily supply side in nature and domestic demand, though far from being exuberant, is coming back. In this kind of situation, over tightening may only choke off the growth recovery instead of being able to clamp down on the sources of the actual inflationary pressures to start with.

Our view is that a terminal rate of 5.5% may be appropriate but, of course, if the growth revival is going to be stronger than expected, then maybe a higher terminal rate would be warranted but looking at the underlying strength of economic activity, we believe that 5.5% terminal rate is warranted as of now.

What will be your view on the rupee being at record low?
We believe that in the current situation, the overall pressures are more towards rupee because of what we are seeing with dollar strength, crude oil prices and with the expected sharper tightening phase from the US Fed as compared to the MPC. In our view the INR could depreciate to about 79 to the US dollar but given the higher forex reserves, the low likelihood of large FII debt outflows given the fact that a lot of that is already behind us and then narrowing inflation differentials with large global economies, we do not think that there is going to be too much depreciation ahead.

We think that the size of the foreign exchange reserves is huge even though it has come down in the last few months. But it is still quite substantial and at a current account deficit expectation of 2.7% of GDP for FY23, we believe the INR may not breach 79 in a hurry and even if it does breach it,we expect it to pull back from a lower position fairly rapidly.

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