CPI inflation to rise above RBI's mid-term target of 4%, says UBS report

Due to factors like rise in rural wages and transient impact of GST

Consumer price inflation is likely to rise above RBI's medium-term target of 4% in 2017-18 due to factors like rise in rural wages and transient impact of goods and services tax (GST), said a report.

The uptick in underlying price pressure could push the RBI to hike rates this fiscal, said the report by UBS.

The global brokerage has estimated average consumer price index (CPI) inflation, excluding the house rent allowance, is expected to be at 4.2% and 4.5% for 2017-18 and 2018-19, respectively.

Further, UBS has estimated CPI inflation (excluding HRA) in second half of 2017-18 to average at 5-5.5%, while the inflation in the first half of the fiscal is likely to be recorded around 3-3.5%.

"While headline inflation remains contained compared with previous highs, we believe upside risks to CPI inflation clearly persist.

The report has attributed the possible rise in inflation to eight factors including pent-up consumption demand on remonetisation, a rise in rural wages, an increase in minimum support prices (MSPs) for agricultural crops and movement in global commodity prices and rising input costs.

Gradual closing of the output gap, an HRA increase under the seventh pay commission, the transient impact of GST implementation and an expansionary fiscal policy, are the other factors to adversely impact inflation.

Accordingly, UBS noted that while a prolonged pause and neutral policy stance from the RBI's monetary policy committee, its next move is likely to be a hike.

"We believe any uptick in underlying price pressure would push it to hike rates. In such a scenario, we would assign a higher probability of a rate hike to commence in 2017-18 rather than being delayed to 2018-19," the report said.

"That said, we believe any tightening (limited to a cumulative 50 basis point hike in the repo rate) would be largely a preemptive step to ensure inflation expectations remain contained," it added.

At the same time it noted that a weak credit growth, a delayed investment cycle recovery and a gradual economic recovery imply that any "aggressive" interest rate hikes are not in the cards yet.