India's easing inflation is only a temporary reprieve for PM Modi

India’s retail inflation eased from the fastest pace in 17 months, offering some respite to policy makers and bond investors battling the fallout of Prime Minister Narendra Modi’s expansionary budget.

Consumer prices rose 5.07 percent in January from a year earlier, the Statistics Ministry said in a statement in New Delhi on Monday, in line with the 5.1 percent Bloomberg consensus. However, the central bank forecasts the pace could pick up to as fast as 5.6 percent by September once the government begins spending for the year starting April 1.

"The CPI will move upwards" on implementation of the budget proposals, said NR Bhanumurthy, Delhi-based economist at the National Institute of Public Finance. "Forget about interest rate cuts, get ready for rate hikes instead."

Investors still braving Asia’s worst bond market will now turn to the minutes of the Reserve Bank of India’s latest meeting -- due Feb. 21 -- to gauge the direction of interest rates in the coming months. The RBI last week reiterated its commitment to contain inflation at about 4 percent over the medium term and more members of the six-strong monetary policy committee turned hawkish: one voted for a rate hike and another gave up his call for cuts.

Upside Risks

While most voted to keep the benchmark repurchase rate unchanged, the prospect of higher borrowing costs could make it tougher for Modi’s government to revive growth in time for national elections next year. The administration this month said it will widen its budget deficit targets to increase spending in the current fiscal year through March 31 and the next 12 months.

Morgan Stanley predicts the RBI will tighten between October and December -- or even before. Analysts led by Derrick Kam are watching oil costs, the impact of minimum guaranteed prices for crops and trends in government expenditure and rural wages.

"We do think that moderate risks are emerging on account of the wider-than-targeted fiscal deficits," they wrote in a note before the inflation data. "The risks are also tilting towards an earlier-than-expected rate hike."