CPI inflation could see upside pressures thereon as some benefits from a high-base effect will begin to wear out and as the imported component of inflation nudges up. Also, as the economy is remonetized, some pent-up demand will have returned. The stickiness in core inflation despite a continued decline in other parts of the index is a worry since wage-price negotiations based on a sticky core can potentially lift overall inflation.
The Monetary Policy Committee (MPC) review of February 8 reiterated its medium-term inflation target of 4%. Given the inflationary pressures in the economy, policy space now remains constricted. The repo rate was accordingly left unchanged at 6.25%, and the monetary policy stance was shifted from being ‘accommodative’ to ‘neutral’. That could very well mark the end of the current rate cut cycle, which began in January 2015 – at least in the near term. The shift reflects the central bank’s decision to exert caution on the inflation front in its journey towards the medium-term inflation target.
CRISIL also expects CPI inflation to inch up to 5% in fiscal 2018, from an estimated 4.7% in fiscal 2017. This will be driven by 1) rising global oil and commodity prices amid geopolitical tensions and a weaker rupee (that can drive up imported inflation), and, 2) core inflation (non-food, non-fuel), which, despite seeing a small demonetisation-led decline, remains firm and could rise as demand picks up mildly in fiscal 2018. However, a prudent Union Budget does cap the upside pressures that a populist one could have had on inflation.
While the Index of Industrial Production (IIP) had failed to capture the impact of demonetisation in November owing to the base effect, the latest number does so. IIP fell by 0.4% on-year in December on the back of 2% contraction in the manufacturing sector. The decline in IIP was limited owing to a weak base of last year. That said, mining and electricity sectors managed to display healthy growth of 5.2% and 6.3%, respectively. When viewed from the user-based classification, the biggest negative contribution to IIP growth came from the consumer goods segment.