CPI Inflation Touches a 5-Month High on Non-Core Pressure

The Consumer Price Index (CPI), a measure of retail inflation, touched a five-month high of 3.81% for the month of March 2017. The higher retail inflation was on the cards due to pressure from oil prices. The Monetary Policy Committee (MPC) has in the past highlighted the possibility of upside risks to inflation due to the pressure from non-core inflation. That seems to be playing out in the macro economy currently.
    
How inflation panned out across rural and urban India…

The overall inflation for the month of March 2017 came in at 3.81%, which is the highest level in the last 5 months. CPI is up nearly 16 bps from the level of 3.65% for the month of February 2017. Interestingly, food inflation for the month is down to 1.93% from 2.01% in the previous year. The other big shift in inflation that is visible is that the urban inflation has gone above the rural inflation on an overall basis. There is a slight negative bias to this data point. The rural inflation in the last few months has been down because the impact of demonetization has reduced the incomes and the purchasing power of rural India. That is visible in lower inflation, which is not exactly positive. 

Food inflation has shown a lower trajectory for the month of March and this will be looked in greater detail in the subsequent paragraph where the components of inflation will be evaluated. Suffice to say that the real thrust to inflation seems to be coming from the non-food space. In fact, this is exactly what the MPC had warned in its previous meetings and the upside risks to non-core inflation are clearly visible in these numbers. The positive feature is that the 3.81% inflation is still way below the RBI outer target of 4.5% for the first half and 5% in the second half. If the CPI manages to stay well within these limits, it will be seen as positive for the RBI monetary trajectory.

What were the key components that triggered inflation in March 2017?

The downward pressure on food inflation came from vegetables and pulses, in an exact repeat of previous months. A word of caution here! While disinflation in pulses is understandable after the rapid price increase in the last year, vegetables are a slightly different ball game. There have been fire sales of vegetables across the Mandis and that has largely been responsible for this negative inflation in vegetables. While pulses may continue to see disinflation for some more time, vegetables will soon turn into positive inflation in the near future. That will impact the future trajectory of inflation.

On the positive inflation drivers, cereals at 5.38% and milk at 4.69% have seen upward pressure. In fact, most of the dairies across India have been raising the milk prices consistently over the last few months and that is having an impact on inflation. Sugar and confectionary has seen a sharp spurt in inflation at 17.05%, but that is more because sugar prices are up due to supply shortage. 

Real pressure is non-core and is coming from crude oil…

The real pressure on inflation is coming from higher prices of petrol and diesel. Global prices of Brent Crude have moved up from $44/bbl in November up to $56/bbl currently. The $60/bbl mark is a very critical mark beyond which absorption becomes difficult and the impact is a lot more visible in the form of higher inflation. The global oil prices have been moving up after the OPEC and friendly nations decided to cut their daily oil output by 1.8 million barrels per day (bpd). That has resulted in a 25% rally in oil prices since December 2016. With the US also seeing the benefits of higher oil prices in the form of more shale wells becoming viable, we do not see any downside disruptions in oil prices. That means Brent Crude may continue to hover closer to the $60/bbl mark and will continue to put pressure on the overall non-core inflation in India.

From the RBI rate strategy point of view, the following 4 things need to be kept in mind…

•    The Monetary Policy Committee (MPC) in its February meeting had announced a shift in its monetary stance from being “accommodative” to being “neutral”. Therefore, unless the RBI has a genuine reason to change its stance, it will be hard to get rate cuts unless there is a sharp fall in inflation, which looks unlikely at this point of time.

•    What is more important from the RBI monetary stance point of view is that the inflation must remain within the range of 4.5% in the first half and 5% in the second half. As long as CPI inflation is kept within these limits, the RBI will not entirely give up on the rate cut possibility.

•    RBI is conscious of the fact that a large part of the inflation control in the last 6 months was an outcome of demonetization that resulted in compression in demand. If remonetization leads to a spurt in demand and a consequent rise in inflation, then the RBI may be even forced to consider rate hikes, although it does look like a remote possibility at this point of time.

•    A key consideration of the RBI strategy will be the nature and colour of capital flows. FPI inflows into debt are largely a function of the rate differential. The RBI may have to do a rethink if the Fed gets too hawkish on rates and other global economies also follow suit.

As of now the inflation has been well within the RBI’s comfort range. Markets may have to really worry if the CPI inflation inches closer to the psychological 4.5% mark. Till then, it could be more of status quo as far as monetary policy is concerned.