The Wholesale Price Index (WPI)-based inflation rate for April came in at approximately 9.6% year-on-year (y-o-y), in line with expectations, and lower than the high of approximately 9.9% in the previous month. Inflation for the same period in 2009 stood at around 1.3% y-o-y.
During April, food prices remained subdued (despite a small rise over March) compared with previous months. Overall, moderation in food prices and substantial relief in prices of manufactured food products (with a combined weight of around 34%) provided a breather to the index. While the fuel group index reacted to price hike in early April, non-food manufactured products continued to exert demand-side pressure on the index.
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Amid continuous government initiatives to rein in farm prices, a decent winter crop and projection of a normal monsoon in 2010, there have been early signs of softening of food price inflation (which is approximately 3% lower than the peak in December). Moreover, adversity of the base effect has also started waning. However, the only concern currently seems to stem from the likelihood of demand-side pressures that have begun to get generalized. Overall, we believe, the current hump in the inflation trajectory will be short-lived, with March having seen the peak. Hereon, WPI inflation is expected to start a gradual march downwards, with larger part of the second half of 2010 seeing a headline number of approximately 7% y-o-y.
Over the past three-four months, pace of domestic developments have compelled the Reserve Bank of India (RBI) to shift its policy focus towards inflation anchoring and active management of liquidity. Given these twin objectives, RBI brought in policy rate hikes of 50 basis points (bps) and cash reserve ratio (CRR) hikes of 100 bps in 2010 so far. However, with the headline inflation hinting towards further softening and liquidity marginally reduced (as a result of the consecutive CRR hikes), pressure on RBI could ease somewhat in the coming months.
We believe tightening in policy interest rates is likely to continue in “baby steps” ensuring no negative effect on growth recovery—repo and reverse repo rates will witness a cumulative tightening of 100-125 bps each during FY11. However, with the CRR already at its long-run “steady-state” level of 5.5-6%, RBI is less likely to resort to aggressive use of this policy instrument unless capital flows surprise on the upside.
For February, the inflation estimate was revised upwards to approximately 10.06% y-o-y from around 9.89% reported earlier.
Among manufactured products, the effect of a significant fall in prices of sugar, edible oils and oil cakes, was to a great extent, muted by the higher rise in prices of cotton and man-made textile products, iron and steel—most of which are demand-side (cost-push) influences on inflation which start surfacing as the economic activity picks up. It is precisely this aspect of inflation (driven by expectations) which RBI is trying to anchor. In fact, the unexpected policy action in March was actually a result of this non-food manufacturing inflation nearing 5% y-o-y for February; we estimate this number at approximately 6% for April.
The actual rise in consumer-level prices has consistently reflected in the Consumer Price Index (CPI)-based inflation indices. Weights of the fuel group and metals are significantly less across CPI segments. With food articles having the maximum weightage in consumer price indices, CPI-based inflation has remained stubborn. From February, however, there were some early signs of softening in CPI.
Graphics by Naveen Kumar Saini / Mint