RBI remains vigilant despite moderating inflation

Inflation eases, but not RBI’s task
Inflation eases, but not RBI’s task

Summary

The recent dip in inflation is sizeable and more than market expectations. Notwithstanding this, the CPI trajectory may not align well with the RBI’s projected inflation path.

The significant easing in pricing pressures in August comes as a big relief, especially after the sharp spike seen in July. The consumer price index (CPI) inflation dipped to 6.8% year-on-year in August from a 15-month high of 7.4% in the previous month. Note that this is the first sequential drop in headline CPI in 2023.

But when looking at it from the central bank’s lens, there are some unsettling revelations. True, the recent dip in inflation is sizeable and more than market expectations. Notwithstanding this, the CPI trajectory may not align well with the Reserve Bank of India’s (RBI’s) projected inflation path.

For perspective, the CPI inflation in the first two months of the September quarter (Q2FY24) has averaged higher than the RBI’s projection of 6.2% for the quarter. This means to meet the RBI’s projections, the CPI print in September would have to ease quite sharply.

Graphic: Mint
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Graphic: Mint

According to Emkay Global Financial Services, “The impact of the 200/cylinder cut in LPG prices will likely reflect in the September CPI print, and may shave off 20-25 bps from the headline rate." Still, the CPI reading for Q2 is likely to be above the RBI’s projection, which has already been revised higher by a meaningful 100 bps by the central bank in the August monetary policy meeting. Thus, an upward revision in the RBI’s Q2 projections is on the cards.

As such, the central bank has pencilled in a significant easing in price pressures in H2FY24. The path is filled with several challenges. The progress of the monsoon so far has been disappointing in September, after August was the driest month on record. This, along with lingering worries about continuing El Nino-related weather conditions pose an upside risk to the already-elevated food inflation trajectory.

To be sure, the much-celebrated drop in food inflation also has some spoilers. Inflation in heavyweight cereals and pulses continues to be in double-digits, underscoring the stickiness. For vegetables, it is the second highest reading in almost 40 months since the covid-related supply disruptions.

One must also consider that the adverse base effects for fruit and vegetable prices are likely to kick in by the end of 2023. Note that vegetable prices were in deflation from November through June.

And not just the food basket, risks loom large for non-food inflation too. Fuel inflation has risen in August after a steady fall. If the recent rise in international crude oil prices persists amid the supply cuts, it could add further upside pressures to the fuel inflation trajectory.

Amid the clouds, a silver lining has been the sustained broad-based softening in core inflation over the last few months. Core inflation excludes the volatile food and fuel components of CPI and an easing trajectory reflects moderation in demand-side price pressures, coupled with ebbing of input cost pass-through. However, the core inflation, too, is likely to see some uptick owing to consumer spending in the festivals.

Given the upward pressure on inflation on various fronts, there would be a need for some policy recalibration by the central bank. The much-anticipated interest rate cuts by the RBI appear like a distant possibility, for now.

Perhaps this is more so because the economic momentum has held on well in recent months.

The heady cocktail of likely elevated inflation (closer to the upper end of the RBI’s tolerance band of 2-6%) and robust growth dynamics would tweak the odds in favour of a higher for longer pause in policy rates.

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