In the three of the past four normal monsoon years, food inflation has printed above 6%. With rains playing hide and seek, risks have risen this year. Although the surge in consumer inflation in July was anticipated, the 7.4% print did surprise. Some comfort can be derived from the fact that the surge was entirely driven by food, generally the most volatile part of inflation basket.
In July, food inflation zoomed to 11.5% from 4.5% in June, whereas fuel and core fell 3.7% and 4.9%, respectively. Excluding food, July inflation was 4.8%. Within food, vegetables, which typically have a short crop cycle, printed 37% inflation. This should correct soon and normalize once fresh crop arrives. Cereals inflation is stickier and to climb down will need relentless government interventions to improve supply and some luck from monsoons in rest of the season.
After a deficient June and above-normal July, rains have again slipped below the long period average in August. Till August 20, cumulative rains were 7% below the long period average. With El Niño conditions setting in, possibility of dry conditions in rest of the monsoon season, appear to be playing out. Delving into the evolving inflation scenario, the comfort from low non-food inflation, and the dynamics of state-level divergences in inflation, leads to the following three key conclusions:
Though transitory, vegetable inflation will keep the July-September headline inflation much higher than what we had anticipated. Therefore, we have raised our Consumer Price Index (CPI) inflation forecast for this fiscal to 5.5% from 5.0% earlier
The drop in input costs (mirrored in deflation non-food Wholesale Price Index, WPI) will keep a lid on non-food prices. Companies have passed on some part of the cost reduction to the end consumer and used the other to cushion profit margins. This will keep core inflation, particularly for the goods part, at moderate levels
Differing weightages and rural urban/share influence state-level variations in inflation. Some of these variations, particularly in fuel, are man-made as taxation varies and keeps changing at the central as well as the state level for fuels. Bringing petroleum products under the Goods and Services Tax is one remedy.
Other indicators - the Purchasing Managers' Index (PMI), tax collections, credit growth – point to a resilient economy. The first-quarter gross domestic product (GDP) growth can surpass 8%. The good news is that the higher inflation is not coming on the back of strong growth, so the Reserve Bank of India (RBI) can wait and watch. We expect the RBI to maintain a status quo on the repo rate this year. And given the inflation risks, a rate cut early next year is likely for now.
