By Yuvika Singhal, Vivek Kumar and Shubhada Rao
RBI is expected to opt for the first leg of interest rate normalization by hiking the reverse repo rate by 20 bps in the December 2021 policy review, followed by another 20 bps upward adjustment in February 2022.
India’s CPI inflation moderated to a 5-month low of 4.35 per cent in Sep-21 from 5.30 per cent in Aug-21; extending the recent downdraft into the third consecutive month. The sizeable gap down was largely in line with our expectations but posed a favourable surprise to market consensus (QuantEco Research: 4.41 per cent, Reuters consensus: 4.50 per cent). The impact of the benign sequential momentum at 0.18 per cent MoM (vs. 0.25 per cent in Aug-21 and Apr-July average at 0.9 per cent) on the headline inflation was outsized by a favourable base.
Looking ahead, we see the recent comfort on inflation to continue well into Q3 FY22, with a pickup in sequential momentum getting more than offset by a favourable base. The inflation trajectory is however expected to move up in Q4 FY22 with readings possibly testing yet again RBI’s upper threshold of inflation band of 6.0 per cent.
Assessing the recent inflation comfort
After peaking out in May-21 at 6.30 per cent owing to the second wave-induced supply disruptions, CPI inflation has eased successively over the last four months. While still above the mid-point, recent inflation prints, by reverting to RBI’s inflation tolerance band (of 2-6 per cent) have offered a reprieve. Reflecting this, RBI in its monetary policy review a few days back, pared its FY22 CPI inflation estimate by 40 bps to 5.3 per cent. In terms of trajectory, Q2 and Q3 anticipated CPI outcomes were both lowered by 80 bps each to 5.1 per cent and 4.5 per cent respectively.
On an FYTD basis, the moderation in annualised inflation has been driven by 3 subcomponents of – 1) Food (of which perishables), 2) Pan, Tobacco & Intoxicant and 3) Miscellaneous to a small extent (of which, personal care & effects).
A quick glance at the Sep-21 internals
• For the second successive month, food inflation momentum was extremely tepid at 0.06 per cent MoM compared to the contraction of an equal momentum in Aug-21. The downside in price of perishables – i.e., both fruits and vegetables, along with sub-categories of Eggs along with Meat & Fish, was offset by a sharp increase in the price of – Oils & fats (2.2 per cent MoM) and Sugar and confectionary (3.46 per cent); likely driven by higher festive related demand.
• Fuel inflation momentum rose to 0.74 per cent MoM in Sep-21 from 0.44 per cent in Aug-21, led by the price of LPG and Kerosene, while most other subcomponents registered a contraction. As such, annualized fuel inflation climbed further up to 13.63 per cent – yet another series high amidst an adverse base as well as higher taxes and the run-up in global fuel prices.
• Sequential momentum in core (CPI ex Food & Beverages and Fuel & Light indices) inflation registered a decline to 0.19 per cent MoM in Sep-21 vis-a-vis 0.45 per cent in Aug-21. The relief was primarily on account of Housing prices recording a rare and unexpected contraction in September. Meanwhile, the index for Recreation and Amusement within Miscellaneous subcategory galloped by ~1 per cent in Sep-21, reflecting the opening up of the economy and the accompanied recovery in demand, especially for services. As such, core inflation continued to remain much above headline, at a fairly elevated level of 5.7 per cent in Sep-21.
QuantEco FY22 Inflation outlook and rationale
Undoubtedly, recent inflation prints have provided comfort and corroborate our belief that average CPI inflation will trend lower in FY22 vs. FY21 (of 6.2 per cent). However, we continue to hold on to our average inflation estimate of 5.6 per cent for FY22 (higher than RBI’s downwardly revised estimate), owing to the following two reasons –
• Over the last one month, global crude oil prices have seen a sharp ascent. Reflecting this, India crude basket after registering an increase of 3 per cent in Sep-21 has further hardened by nearly 11 per cent in Rupee terms, so far in Oct21. A lagged pass-through to domestic prices has meant petrol and diesel prices being revised upwards to the tune of ~2.0 per cent and 3.0 per cent respectively so far in the month. This along with escalation in domestic coal prices are likely to keep fuel inflation elevated in the near term.
• Ongoing tapering of lockdown restriction by states along with improving vaccination coverage could bring pent-up demand and revenge spending together. Economic activity as captured by our proprietary DART index for the week ending 10th Oct-21 bounced back to a fresh post-pandemic high, led by an impressive improvement in mobility indicators.
International evidence so far suggests that when vaccination attains a critical mass, then it is accompanied by rapid improvement in economic confidence along with a build-up in inflationary pressures. India has so far inoculated 50.0 per cent of its population (with 19.6 per cent fully vaccinated) with one dose of vaccine. Going forward, we expect almost the entire adult population to get partially vaccinated before the end of 2021. In the short term, this could keep core inflation elevated with downward rigidity despite the persistence of a negative output gap.
Providing comfort, we do expect –
• Moderation in food inflation to continue. Kharif sowing acreage remaining almost at par with last year’s level despite monsoon vagaries and policy interventions in case edible oils and pulses bode well for near term food inflation trajectory. In addition, a late withdrawal of monsoon could help preserve moisture levels and thereby support rabi sowing.
• Some mild downside risk could emerge if the government accepts RBI’s recommendation of lowering fuel taxes. As per our estimates, a Rs 5 reduction in petrol and diesel excise duties could offer a reprieve of 15-20 bps on CPI inflation, first and second-order impact combined.
In terms of trajectory, we see the ongoing comfort on inflation to continue well into Q3 FY22, with a pickup in sequential momentum getting more than offset by a favourable base. The inflation trajectory is however expected to move up in Q4 FY22 with readings yet again testing RBI’s upper threshold of inflation band of 6.0 per cent.
From a rates perspective, we stick to our view of backloaded normalization in monetary policy in FY22. This is premised on the expectation of no major severe Covid wave in the near future – with vaccination in the meanwhile providing a strong growth pivot, thereby prompting a gradual scaling back of emergency support measures, both domestically as well as globally (few central banks in DMs and EMs have already commenced/about to begin policy normalization in a phased manner).
We continue to expect the RBI to opt for the first leg of interest rate normalization by hiking the reverse repo rate by 20 bps in the Dec-21 policy review, followed by another 20 bps upward adjustment in Feb-22. The second stage of interest rate normalization would begin with a 25 bps hike in the repo rate in Q1 FY23.
(Yuvika Singhal is an economist at QuantEco Research. Vivek Kumar is an economist at QuantEco Research. Shubhada Rao is the founder of QuantEco Research.)
(Disclaimer: The views expressed in the article above are those of the author’s and do not necessarily represent or reflect the views of Autofintechs.com. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.)