Why easing inflation can’t offer relief, yet

Food prices, especially those of vegetables, typically ease at this time due to winter arrival of crops in the market. This was observed in November: food and beverage inflation was outpaced by headline inflation for the first time since February, as it cooled by 203 basis points from October to 5.07%. Vegetables, an item in this group, slipped into deflation: prices declined 8.08% from a year ago, compared to a rise of 7.77% in October.

 

This was the big relief of last month, as food and beverages—the biggest component of India’s consumer price index—had been disproportionately pushing headline inflation up this year, contributing 52% in September. The contribution has now come down to 40%.

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But the “winter disinflation" is unlikely to sway the monetary policy committee (MPC) towards pausing repo rate hikes just yet—and for good reason. After the 35-basis-point hike earlier this month, analysts widely expect another increase of 25 basis points in February, as RBI Governor Shaktikanta Das’ statement suggested a hawkish tone despite signs of easing inflation.

Pipeline Pressures

One likely reason for the hawkish stance is, inflation merely dipping below 6% aided by base effect won’t be enough. That mark is just the upper end of the RBI’s inflation mandate. “The emphasis is on first bringing inflation into the target range and lowering it to 4%, which is the target," a Barclays report said last week. Das, too, said the panel would “keep Arjuna’s eye on the evolving inflation dynamics and be ready to act as may be necessary".

While all signs point towards easing inflation, bringing it down to 4% could be a tough task. This has been a year of high input prices, which producers are finally passing on to consumers, but the pass-through is not yet complete. This means retail prices still face an upward risk if demand continues to recover.

A Crisil analysis computed the ratio between two components of the wholesale price index—one based on input-side items and the other on output-side items. Over the past decade, the input-side prices have been 0.94 times the output side. This year, the ratio reached 1.03 in May to July. It eased to 1 in October but still exceeds the decadal average. A higher ratio shows input price pressures continue to remain higher than output price rises.

Besides, core inflation remains sticky above 6%, as it has been in all but two months since March 2021, and several food items other than vegetables recorded higher inflation in November than October.

Arjuna’s Eye on…?

According to Goldman Sachs, lower food inflation alone contributed to a decline of 93 basis points in headline inflation, meaning other items that constitute the index still pose a risk. Of the 299 items for which consumer price index data is available, 141 recorded an uptick in the inflation rate in November compared with October, Mintcalculations show. In October, 130 items had seen such an uptick. The items where inflation rose in November included cereals and milk (and related products), which have significant weight in the inflation basket. Indeed, then, inflation is still where Arjuna’s eye needs to be. But while RBI has been more focused on managing inflation for much of this year, new challenges may emerge going into the next year. The risks to growth are knocking, too, due to the imminent global slowdown. This means a February 2023 rate hike could be followed by a pause soon, and even rate cuts can’t be ruled out, especially in the run-up to the 2024 General Elections. There are also signs of divergence within the monetary policy committee, with two of the six members voting against the continuation of the policy tightening stance in the latest meeting. (Their rationale will be clear when the minutes of the meeting are released next week.)

 

This was the big relief of last month, as food and beverages—the biggest component of India’s consumer price index—had been disproportionately pushing headline inflation up this year, contributing 52% in September. The contribution has now come down to 40%.

But the “winter disinflation" is unlikely to sway the monetary policy committee (MPC) towards pausing repo rate hikes just yet—and for good reason. After the 35-basis-point hike earlier this month, analysts widely expect another increase of 25 basis points in February, as RBI Governor Shaktikanta Das’ statement suggested a hawkish tone despite signs of easing inflation.

Pipeline Pressures

One likely reason for the hawkish stance is, inflation merely dipping below 6% aided by base effect won’t be enough. That mark is just the upper end of the RBI’s inflation mandate. “The emphasis is on first bringing inflation into the target range and lowering it to 4%, which is the target," a Barclays report said last week. Das, too, said the panel would “keep Arjuna’s eye on the evolving inflation dynamics and be ready to act as may be necessary".

While all signs point towards easing inflation, bringing it down to 4% could be a tough task. This has been a year of high input prices, which producers are finally passing on to consumers, but the pass-through is not yet complete. This means retail prices still face an upward risk if demand continues to recover.

A Crisil analysis computed the ratio between two components of the wholesale price index—one based on input-side items and the other on output-side items. Over the past decade, the input-side prices have been 0.94 times the output side. This year, the ratio reached 1.03 in May to July. It eased to 1 in October but still exceeds the decadal average. A higher ratio shows input price pressures continue to remain higher than output price rises.

Besides, core inflation remains sticky above 6%, as it has been in all but two months since March 2021, and several food items other than vegetables recorded higher inflation in November than October.

Arjuna’s Eye on…?

According to Goldman Sachs, lower food inflation alone contributed to a decline of 93 basis points in headline inflation, meaning other items that constitute the index still pose a risk. Of the 299 items for which consumer price index data is available, 141 recorded an uptick in the inflation rate in November compared with October, Mintcalculations show. In October, 130 items had seen such an uptick. The items where inflation rose in November included cereals and milk (and related products), which have significant weight in the inflation basket. Indeed, then, inflation is still where Arjuna’s eye needs to be. But while RBI has been more focused on managing inflation for much of this year, new challenges may emerge going into the next year. The risks to growth are knocking, too, due to the imminent global slowdown. This means a February 2023 rate hike could be followed by a pause soon, and even rate cuts can’t be ruled out, especially in the run-up to the 2024 General Elections. There are also signs of divergence within the monetary policy committee, with two of the six members voting against the continuation of the policy tightening stance in the latest meeting. (Their rationale will be clear when the minutes of the meeting are released next week.)

“[If] growth significantly disappoints, we would expect the timeline to achieve the 4% target to be implicitly pushed out…Pressure to support growth may also increase ahead of the elections," said a Nomura report, which has projected cumulative rate cuts of 75 basis points in July-December 2023. Before new challenges set in next year, the RBI may want to use all tools at its disposal to control inflationary pressures, which despite signs of easing, remain a risk.

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