RBI inflationary expectations should soften in September

Apart from the monsoon and Fed hike risks, most of the domestic pre-conditions laid out at the August review have been fulfilled. Commodity prices (INR terms) have eased further, with the CRB index (Thomson Reuters/ Core commodity index) down 1.5% since August. Inflationary expectations are also expected to ease in September, mirroring the global commodities' down move. 

From a high of 7% YoY a year ago, CPI inflation fallen to 3.7% in July and August. The central bank had emphasised that it would look through base-effect-distorted inflation readings in these two months but the slower-than-expected sequential pace probably took it by surprise. 

"Our estimates suggest that the impact of below-normal monsoon lasts for 3-4 months, implying that inflation will likely stay within 5.0-5.5% through December", says DBS Group Research.

Next, better policy transmission should also help. To improve the sensitivity of retail rates to policy changes, the RBI proposed a regulatory change whereby banks would need to consider marginal cost of funds to calculate lending rates. The box that still needs to be ticked is the government's structural measures, which hit a roadblock at the recent parliamentary session. Few supply-side measures have been fixed and bigger structural changes remain in the slow lane. 

"We expect the reform agenda to be re-visited after next month's state elections, implying the impact won't be felt for some time yet", added DBS Group Research.