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March 07, 2017

EcoView: Pricking the inflation balloon

This report is available to users in India for ₹5,000 + applicable taxes

 

The inflation ascent: How worrying is it?

 

While Wholesale Price Index (WPI) based inflation spiked to 6.6 %, the rise in CPI based inflation to 3.6% wasmodest in February. But without doubt, inflation has bottomed out. This is happening not only in not only in India,but globally as well. Inflation in the United States, European Union and Japan has started picking up although itremains within central bank targets. These developments have shifted global narrative from deflation toreflation. Rising crude and commodity prices along with improving growth prospects have given an impetus toglobal inflation.

 

Sensing the pressure on inflation, the Reserve Bank of India (RBI) did not cut the repo rate in its February reviewof the monetary policy. This is despite the inflation print coming below their expectation and some anticipated hitto consumption demand from demonetisation. In fact, in the last policy, they surprised the markets by changingthe monetary policy stance to ‘neutral’ from ‘accommodative’.

 

Risks to inflation

 

CPI inflation could see upside pressures hereon for the following reasons:

  • A gradual pick-up in the global commodity prices. The uptrend in global commodity and crude prices is likely to continue through 2017. The World Bank foresees global metals prices rising 10-15% in 2017. Similarly, crude prices will average at higher level in 2017 than 2016.
  • Sticky ‘core’ inflation. Supply constraints, service tax increases and now Goods and Services Tax (GST) will keep core inflation. Core inflation has over 54% weight in CPI.
  • Risk of ‘El Nino’. It is early days for a firm monsoon prediction, but initial forecasts point towards risks of El Nino to monsoons. If this materializes, food inflation could be under pressure. Rising global food prices also do not augur well in this context
  • Low-base effect on food inflation is wearing off