By Yuvika Singhal, Vivek Kumar and Shubhada Rao
Average CPI inflation in FY22 continues to remain at 5.6%, close to RBI’s revised estimate of 5.7%. The CPI inflation eased to a 3-month low to return within RBI’s tolerance band in Jul-21, coming in at 5.59% compared to 6.26% in June 2021.
CPI inflation eased to a 3-month low to return within RBI’s tolerance band in Jul-21, coming in at 5.59% compared to 6.26% in Jun-21. The print was marginally below our expectations (pegged at 5.72%) but almost in line with market consensus (5.6-5.7%).
The deceleration was predominantly an outcome of a favourable base, even as sequentially prices rose by 0.74% in the month compared to 0.56% in Jun-21. Price pressures were broad-based, intensifying across all categories with the exception of food compared to the previous month.
A quick glance at internals in Jul-21
• Food inflation momentum eased, albeit marginally from 1.18% in Jun-21 to 0.86% in Jul-21. Looking at internals, we find that price of oils & fats contracted for the first time in over a year (-0.87%MoM), along with that of pulses (-1.20%). It appears recent government supply-side interventions for both these commodities have begun to come to fruition. However, the downside in food momentum was curbed by higher price pressures in index heavy categories of Vegetables and Milk (recall, leading players such as Amul, Mother Dairy had raised prices in Jul-21) along with Meat & Fish. Overall, annualized food inflation moderated to a 3-month low of 4.46% in Jul-21 compared to 5.58% in Jun-21.
• Fuel inflation momentum picked up to 0.56% compared to 0.25% in Jun-21, reflecting the upward adjustments in the price of LPG and other fuels such as Kerosene and Diesel ex-conveyance. Transport and Communication within Miscellaneous continued to see a sequential build-up of more than 1.0%MoM for the third month, reflecting the pass-through of higher crude oil price to retail petrol and diesel costs reigning at all-time highs. As such, consolidated annualized fuel inflation continued to remain elevated, easing a tad to 14.80% versus 15.22% in Jun-21.
• Offering additional comfort, Core inflation (CPI ex Food & Beverages and Fuel & Light indices) eased to 5.94% in Jul-21 after ruling above 6.0% over the months of May-21 and Jun-21. Akin to the headline, a positive base offered this reprieve, even as sequentially prices rose by 0.74%MoM. Structural characteristics of CPI inflation. We find evidence of goods inflation being prominent, and that too is highly concentrated in nature.
• Goods inflation in driver’s seat: All of the inflation upside since the pandemic has been led by goods. The contribution of services to headline inflation has remained marginal and fairly sticky in the 110-120 bps range (see chart).
• High concentration: Three items, namely – Oils and fats, transport and communication (of which fuel costs) and Fuel and light, together with continued to contribute as much as 264 bps to headline inflation (i.e., ~47%) in Jul-21; an indication of elevated concentration of inflation pressures.
Our forecast for average CPI inflation in FY22 continues to remain at 5.6%, close to RBI’s revised estimate of 5.7%. There remain risks on either side of our estimate, albeit evenly balanced in our opinion.
On the upside, the persistent rise in global commodity prices remains the most predominant factor. On one hand, this is reflected in elevated prices of industrial raw materials. On the other, it works through higher crude oil prices with the India crude basket averaging at ~$70 PB on an FYTD basis compared to an average of $45 PB in FY21. Both these stand to get exacerbated by the anticipated depreciation in the Indian rupees towards 75.0 by Sep-21, and further towards 77.0 by Mar-22.
On the downside, several factors are at play –
• A pick up in area sown under Kharif crops, now only 2.0% lower versus last year level’s (as of 6th Aug-21) augurs well for the food inflation outlook, as do adequate food stocks of food grains.
• Supply-side interventions such as allowing imports of pulses after a gap of 3 years (up to Oct-21), imposition of stock holding limits on pulses, reduction in excise duties on select edible oils for a period of 3 months already appear to be assuaging price pressures.
• A gradual tapering of state-level lockdown stringency starting Jun-21
• Still subdued demand conditions which could perhaps see a backloaded recovery, more in favour of services than goods.
How this shapes up will be intrinsically linked to the progress on vaccinations.
• A taxation related possible relief on fuel (something which the RBI has been reiterating), which as per our estimates of Rs 5 reduction on both petrol and diesel excise duty could soften CPI inflation by 15-20 bps in a combined direct and indirect impact.
Notwithstanding these divergent factors at play, the threshold for tolerating inflation above target by RBI in FY22 may remain strong amidst still truant broad-based and durable growth impulses in the economy.
From a monetary policy perspective, this will mean a backloaded normalization in FY22. This is somewhat premised on the expectation of a pickup in vaccination coverage close to 60% of the population with a single dose by year-end, which could mean a pivot not just for growth rebound but also demand-led price pressures getting activated in the economy.
In the same line, we expect the accommodative stance to switch to neutral in Dec-21, with the central bank seeking to restore the width of the LAF corridor to 25 bps from 65 bps currently via an upward adjustment in the reverse repo rate. As such, we expect the reverse repo rate to be hiked from 3.35% currently to 3.75% between Dec-Feb FY22. This is likely to be followed by an eventual 25 bps hike in the repo rate in Apr-22.
Also Read: India macro tidings: Return of stagflation?
(Yuvika Singhal is an economist at QuantEco Research. Vivek Kumar is an economist at QuantEco Research. Shubhada Rao is the founder of QuantEco Research.)
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