Decline in inflation can favour rupee and help rate-cut

India's retail inflation eased to three-month low of 5.10 per cent in January from 5.69 per cent in December, largely due to the decline in food inflation to 7.58 per cent and a favourable base. If this trend continues for some time, it is bound to favour the rupee. While headline retail inflation cooled in January, it has now spent 52 consecutive months above the RBI medium-term target of four per cent. On a positive side, inflation has now been within the tolerance range of 2-6 per cent for the fifth successive month.

At the all-India level, while CPI inflation declined by 270 bps to 5.10 per cent in January as compared to the April’22 level, the weighted contribution of core CPI declined by 170 basis pointsduring the same period. Since the decline in core, as per SBI’s internal economic research, is visible in both rural and urban areas and in goods and services that are quintessential to the day-to-day living, to confer that core decline is a proxy for decline in demand or rural slowdown is misleading. The only reason for this phenomenon could be the changing purchasing behaviour of customers. Experts believe that people are actively using e-commerce websites to buy these essentials, which explains why demand is migrating from offline to online mode. If this is durable, then core inflation decline could be quite enduring.

Inflation for the miscellaneous sub-group, which includes various services, fell below four per cent after a gap of 49 months. This is expected to remain sub-4 per cent until July, which is a good augury, as far as core inflation is concerned.The MPC’s expectations around the growth outlook and its forecast that the CPI inflation will moderate while remaining above the four per cent target, reinforces our view of a likely shallow rate cut cycle.

Icra foresees cumulative rate cuts of 50-75 bps, commencing in the August meeting, and a stance change in the preceding review, after some visibility on the monsoon turnout.The RBI's policy has been somewhat pegged to the Fed, specifically in the last two years, even as it formally targetted inflation. Emkay opines that shifting debates on global narratives requires the RBI to also be flexible.

Hence, one can expect that the central bank will not precede the Fed in any policy reversal in CY24, while policy management will have to stay vigilant amid fluidity of global narratives.This decline in inflation is contributing to an increase in the real yields on rupee-denominated debt, as well as widening the real yield gap compared to other major currencies.

This trend could favour the rupee, particularly against European currencies, Yen and the Yuan. However, Kotak Securities anticipates a limited impact on the USDINR pair, as it remains range-bound. The US dollar continues to benefit from a robust economy and high real yields, which might mitigate any significant appreciation of the rupee against the dollar.