Rains key to CPI target
If El Nino occurs by summer, it will drive rain clouds away and have an effect on June-September monsoon
The coming monsoon holds the key to Consumer Price Index (CPI) inflation. As it is, hailstorms have driven up food prices and pushed March CPI up to 8.3% from 8.0% last month. A 5.0% swing in food prices affects CPI inflation by 250 basis points (bps). Core CPI inflation, despite a marginal fall, remains high at 7.8% as housing price inflation is overestimated at around 10.0%. Food price inflation has gone up to 9.1% from 8.6% in February.
The Wholesale Price Index (WPI) inflation in March has also rebounded to 5.7% from 4.7% last month. The Indian Meteorological Department’s first monsoon forecast in mid-April will come at a time of rising El Nino risks. On balance, Reserve Bank of India (RBI) governor Raghuram Rajan may hold rates on 1 June.
By mid-April, food prices, both at the retail and wholesale level, rose back to January levels. Weighted average retail food inflation is being tracked at 3.4% in April, higher than March’s 2.7%. At the wholesale level, weighted average food inflation is up to 2.4% in April from 1.8% in March. Across both retail and wholesale prices, main food items that are showing an increase are pulses, vegetables, sugar and milk. On the other hand, cereal prices are softening a bit while food-oil prices stay flat.
Core CPI inflation is expected to remain about 8.0% as long as housing price inflation is over-estimated at 10.0%. Anecdotal evidence suggests that rentals are rising at a far slower pace than CPI housing numbers suggest. If the rise in rentals is taken at a more realistic 5%, CPI inflation will come off to 6.8%, well below the average of 7.1% since 1996.
March WPI inflation surprised on the upside. Agflation increased to 7.7% from 6.3% last month on hailstorm effects. Manufacturing inflation also climbed to 3.2% from 2.8% partly as producers pass on the impact of depreciation to the customer. Manufactured food products inflation (1.9% in March relative to 0.9% last month) and metals inflation (1.7% in March relative to 0.9% last month) were the primary contributors to a higher manufacturing inflation. Finally, fuel inflation was also higher at 11.2%, up from 8.7% in February on base effects.
Bank of America-Merrill Lynch core-WPI (excluding food, fuel and metals) increased to 4.3% from 3.4% last month. Most of this increase is explained by higher coal inflation (0.1% in March relative to -9.7% in February). Non-food manufacturing core-WPI inflation remained at a weak 3.5%, albeit higher than February’s 3.1%, with high rates killing pricing power. Incidentally, a government committee is also slated to recommend a fresh WPI series soon.
IMD’s first monsoon forecast in mid-April at a time of rising El Nino risks will be very important. The Southern Oscillation Index (SOI), a lead indicator, has dipped in recent weeks (a consistent reading below the -8 mark signals an El Nino event). If El Nino occurs by summer, it will drive rain clouds away and impact the June-September monsoon. If it stretches to the fall, India will mercifully escape. The Columbia University Earth Institute reports probabilities for El Nino below 40% through May-July 2014, rising to 59% for June-August, and settling in the 64-73% range from July-September through November-January.
There is a fairly strong correlation between the SOI and the agricultural gross domestic product growth. Concerns remain that this could hurt FY15 growth by 50-75 bps, especially if RBI delays rate cuts due to rising agflation or inflation. CPI inflation will get stuck at 8-10% as El Nino will push up food inflation instead of coming off to 7% levels by 2015.
Edited excerpts from report India Economic Watch-Inflation: To El Nino or not to El Nino by Bank of America-Merrill Lynch.
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