Inflation comes within RBI's tolerance band; is the worst behind for investors?

The Reserve Bank of India (RBI) must be breathing great sighs of relief!

Retail inflation, or the consumer price index (CPI) based inflation, fell below the RBI's upper tolerance level of 6 percent for the first time in 11 months in November, thanks to softening prices of food items and commodities and RBI's measures.

RBI is mandated by the government to maintain retail inflation at 4 percent with a margin of 2 percent on either side till March 2026. Notably, RBI after its December policy meeting had projected retail inflation coming below the upper tolerance threshold of 6 percent in the January-March period.

The inflation print is much better than analysts' expectations. As per Mint, analysts in a poll had predicted annual inflation of 6.40 percent.

Is the worst behind?

The worst in terms of inflation may be behind but it is too early to declare we have won against inflation because while headline inflation eased, core inflation, which is the focus of RBI, is still high.

Headline inflation is the raw inflation figure and it shows the change in the value of all goods and services in the basket whereas core inflation excludes the prices of commodities. In simple terms, core inflation is CPI excluding food, fuel, pan, and tobacco. It is less volatile than headline inflation.

As Mint reported earlier, core inflation remained sticky between 6 percent and 6.26 percent in November, according to three economists' estimates, versus 5.9 percent to 6.3 percent in October.

"While food, clothing and footwear and housing inflation declined in November 2022, inflation of other commodity groups – pan, tobacco and intoxicants, fuel and light and miscellaneous products has firmed up. Core inflation increased to 6.04 percent in November 2022," said Sunil Sinha, Principal Economist, India Ratings and Research (Ind-Ra).

Sinha pointed out that core inflation has remained higher than 5.75 percent in the last 19 months.

"While headline inflation has declined, sticky core inflation remains a cause of concern. Ind-Ra believes that while the headline inflation is under the RBI’s target, sticky core inflation needs continuous monitoring and the RBI is unlikely to lower its guard against inflation. While the extent of the rate hike has reduced, Ind-Ra still expects the central bank to undertake a 25bp hike in February 2023 monetary policy," said Sinha.

Teresa John, CFA, Deputy Head of Research & Economist at Nirmal Bang Institutional Equities underscored core CPI inflation stood at 6 percent which was largely in line with expectations.

"With this reading, we expect CPI inflation to average nearly 6.3-6.4 percent in FY23. CPI inflation below 6 percent gives greater credence to our view that the RBI may not raise rates at the next meeting on account of slowing global growth and moderating inflation. While it is not our base case, we note that the RBI has retained the optionality of a 25bps rate hike at the next meeting with slightly hawkish commentary," said John.

Economists at Kotak Institutional Equities (Kotak Securities) pointed out that November core inflation remained steady at 6.3 percent.

The brokerage said while the downside surprise in November headline inflation will provide some respite to the RBI MPC, elevated and sticky core inflation will remain a cause for concern.

"We now expect the inflation trajectory to undershoot the MPC’s projections by 30 bps in the second half of FY23. Accordingly, we expect the RBI MPC to reduce its hawkish tone in the February MPC meeting and the policy decision is likely to be finely split between a last 25 bps hike and a pause," said Kotak.

Amid the uncertain global outlook, Kotak said it continues to monitor risks from volatile crude oil prices, elevated domestic core inflation, and pass-through of input costs to prices. The brokerage firm expects CPI inflation to average 6.6 percent in FY23E and 5.3 percent in FY24E.

What should you do?

Do not speculate or try to time the market.

While CPI inflation for November came below the RBI’s upper tolerance limit, the Index of Industrial Production (IIP) contracted to 4 percent in October.

Also, it has to be seen if the trend in inflation sustains in the coming months also. Global headwinds still persist. The Ukraine war is still on and the risk of a global economic slowdown is very much there. 

One can assume that the RBI may take a pause on rate hikes in its next policy meet but that is not going to help investors significantly.

"The CPI inflation for November is below the RBI’s upper tolerance limit which is good news. But the Index of Industrial Production (IIP) shows a contraction in October. Taken together, these two macro data suggest that the MPC is likely to refrain from further rate hikes," said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

"However, positive weakness in manufacturing suggests that it can impact corporate earnings, going forward. Since there is no room for further PE expansion, this will put a cap on the market rally," said Vijayakumar.

A lot will depend on the US inflation prints and the FOMC meeting outcome. If inflation eases in the US also and the Fed hints the magnitude of rate hikes will decrease, the market will have valid reasons to be happy.

Investors cannot control macro developments. But they can control their emotions and strategies for investing. If one finds it difficult to navigate through the prevailing uncertainty, he/she may seek the help of a financial advisor.

"Adhering to asset allocation and being patient with one’s investment is the key to a successful investment journey," said Chintan Haria, Head of Product Development & Strategy, ICICI Prudential AMC in an interview with MintGenie.

"If one is unsure how to go about optimal asset allocation, invest in categories like the balanced advantage or multi-asset category scheme. In effect, an investor will not have to worry about any local, global macro or micro developments and be at ease with one’s investments. Continue with SIPs as over a complete market cycle, the investment experience will tend to be superior," said Haria.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.