Inflation will come down to 6.3% by March and to 5.5% by FY24: Indranil Sengupta

Help us understand what is fuelling Indian inflation taking note of the developments in the last few days. Where do you see the trajectory of Indian inflation components from here on? We will talk about the other inflation which is the US inflation?
India’s inflation is largely imported and there are a few agro supply shocks as well. Since commodity prices went up a lot due to the global liquidity infused by the Fed, we too had inflation going up. Now that the Fed is tightening and bringing down commodity prices, inflation in India is peaking.

All commodity prices are falling and effectively speaking, inflation in India has already peaked. Statistically, there will be a bit of a blip, close to 8%. Around September, we should all look through that. Net-net, inflation will come down to 6.3% by March this year to 5.5% by next year, that is FY24.

When do you see the bond market and the stock market getting convinced that indeed the Indian inflation is heading lower because right now it appears that they are not very convinced if all these components coming down mean that the real reading will also head lower?
I think that all the fundamental drivers of inflation are fairly soft. Growth is slow and so we are not seeing much demand. We are seeing good rains and that should bring down agflation.

RBI Governor Das said the central bank has kept money supply very tight and so there is no money driven inflation. Commodity prices are coming down globally as well as the RBI’s high FX reserves provide protection to the rupee. As the numbers begin to roll down, both the equity and the bond markets will be convinced that inflation is yesterday’s story, at least for India.

How did you read the latest US inflation reading and its components, especially rent, shelter, etc. Also, how do you recommend we should all look at the US inflation differently? What are the fundamentals drivers there?
The big difference between the US and Indian inflation is that US inflation is largely driven by cheap money. If you look at M2 for example, which is the money supply, in the US that had crossed 20% versus a long-run average of 7%.

In India money supply has been lower than 14-15% which is the long run average and therefore what is gradually happening is that the constituents of US inflation which are rising, suggest that it is the demand side pressure which is pushing up inflation rather than just the supply shock.

At least experience shows us that when you have money driven inflation like the US had seen in ‘70s and the early 80s and India saw till maybe the mid ‘90s, it takes time for that to come down and, in fact, history says that the Fed has always had to tighten so much that they create a recession for inflation to come down. So, there is a fundamental difference between supply shock driven inflation that we are seeing in India and cheap money driven inflation that we are seeing in the US.

There is a sense in the market that the way numbers are pouring in, there is a case building for a mild inflation in the US; mild enough to break the back of commodity, energy but not deep enough to completely push the US economy in a tailspin. If that indeed happens, then going forward, the pace of rate hikes may slow down and by mid next year, there may be QE. Do you believe in this probability?
The history of inflation shocks in the US suggest that they typically take more than a year to come down. So when inflation has gone to where it has at 9% plus, we at least do not see it returning to the 2% level next year in the US. We are looking at about 200 basis points of hikes by the US from here on as well as QT and if that happens, the RBI will probably have to go to a terminal repo rate of around 6% at home.

How are you analysing the quality of growth because when this kind of a growth slowdown happens across the world –Europe is facing issues, China is under lockdowns and the US is orchestrating a slowdown to cool down commodity prices – where does this put India as far as the growth trajectory is concerned?
We are looking at growth at around 6.7% this year. Of course, the June quarter will be statistically higher and then 5.5% next year. Now again, based on experience, we estimate that the US recession will typically cost about 100 bps of GDP growth for India. It remains to be seen whether that happens but I think it is fair to assume that growth will be in the five handle in FY24 and that is why towards the end of FY24, we will see RBI cutting rates by 50 bps.

How are you looking at the ingredients of growth, capacity utilisation etc when you look at which are the sectors which appear to be in good shape and where things are looking challenging?
There is no major engine driver of growth which is really in a good shape, whether it is in India or anywhere else in the world. We have a consumption problem; demand is weak and the RBI’s Consumer Confidence Index is still below pre Covid levels.

At CLSA, we run an India Activity Index that is up about 6% from 2019 levels. So, consumption is weak and because of lack of capacity utilisation, capex also remains muted outside of what the government is doing. We have been in troubled times and those troubled times continue to a lesser degree but the global picture is again worsening.

We also saw credit growth in India come upwards of 13% in almost three years and that too two months in a row. Is it a good sign that credit growth is finally coming back?
We have been looking at a pickup in credit growth largely because real lending rates have been low and nominal GDP growth is going up. Typically, when you come out of a big shock like the great financial crisis of 2008 or the Covid shock of 2020, there is a bit of a relay race.

So, first retail credit demand picks up. As there is demand by consumers, corporates start to look at working capital which I assume is what is happening now and finally when capacity is exhausted, we see capex growth. That is at least two, three years away but so far credit growth has been largely driven by retail demand and now corporate demand will kick in.