At last, inflation seems set to soften and stay in a relatively cool range

Headline inflation has since drifted lower, notwithstanding sequential swings around the monsoon months and on weather-related triggers. From 6.4% in 2022-23, Consumer Price Index (CPI) inflation eased to 5.2% in 2023-24 and is likely to settle in a range of 4.2-4.6% this year.

August 2024 inflation came in slightly above expectations, mainly on a divergence in food versus ground-level data. Food prices corrected much less than expected across sub-segments like pulses, vegetables, cereals, sugar, etc. 

Other segments were along expected lines, with continued disinflation in fuel and modest service-sector pressures. Core inflation (sans food and fuel) held steady at 3.4% year-on-year, pointing to a slight pass-through from telecom tariff hikes.

Also read: August inflation: What CPI data tells us beyond the base effect, in charts

There were indications that diesel and petrol prices might be cut if global crude oil (currently at a three-year low) stays soft. Brent crude is down 10% month-to-date versus 2023-24’s average. Food costs have eased in September and we will need to see if this is reflected in sub-trends.

Either way, receding base effects were expected to keep the headline print above 4% in September. Headline inflation’s softer numbers in July-August and the likelihood of a small uptick in September suggest that the Reserve Bank of India’s (RBI) current quarter’s inflation forecast of 4.4% will be undershot by at least 30-40 basis points.

Beyond base effects: There are three reasons to be sanguine over the inflation trajectory. First, the monsoon has been encouraging, with a sharp shortfall in June narrowing in July and August. 

As of 7 September, cumulative rainfall stood at 8% over its long-term average (LTA), even though the geographical spread is still relatively uneven, with the southern peninsula and central region in sharp surplus, while other regions are below their LTAs. 

Reservoir levels have gone up, with current live storage above 80% of full capacity at August-end, up from 63.4% at this point last year. This eases the kharif-to-rabi crop shift and bodes well for farm output.

Second, food costs are off the boil. High frequency data for vegetables has begun to cool off. So also cereals and pulses. Price spikes for staple vegetables have moderated. 

Timely rainfall, better inter-state supplies and stepped-up pulses output are expected to help keep volatile food components in check for the rest of 2024-25. Rains have temporarily stoked vegetable prices again in August-September, but these are expected to moderate next month.

Lastly, core inflation and its second-order impact are likely to be benign. In a note earlier this year, we had assessed the reasons behind the considerable gap between core and headline inflation at the time. 

Also read: Will a surprise uptick in August inflation put RBI rate cut timeline in limbo?

Back then, core inflation was expected to bottom out by around mid-2024 and then turn up on base effects, accompanied by a modest pick-up in consumption trends on the back of easing inflationary expectations, higher labour participation, positive wealth effects and easier financial conditions. To that extent, we had expected core inflation to ‘catch up’ with the headline rate and average 3.5% year-on-year in 2024-25.

Our view on core CPI has played out in the past two months, mostly driven by base effects and weak input costs (thanks to soft commodities). Wage pressures, on an inflation-adjusted basis, remain at manageable levels, calming concerns over a potential wage-push spiral or second-round effects from high inflation.

Our correlation study had shown that softer consumption also tends to impart a disinflationary impulse to core segments. Add to this the reading that inflationary expectations are anchored, even if they have stopped correcting further. The small pick-up in the May-July surveys was likely influenced by the weak monsoon start and resultant uptick in food costs (which has since faded).

Implications for policy: Our trimmed mean measure is running at a more benign pace than swings in the headline print. Three important developments will likely be under watch to gauge the direction of RBI policy.

 First, the four-year term of the three external members of its six-member Monetary Policy Committee (MPC) is set to conclude next month and new members might be announced ahead of the October policy review. 

Two of the external members have been doves in the mix, casting a dissent vote in majority MPC decisions to keep rates on hold. We assume the incoming members will prefer to maintain the status quo in October, but this could be followed by a broader MPC shift in December as more inflation and growth data becomes available.

Second, the US Fed is widely expected to kick-start a rate-cutting cycle this quarter, with its policy panel’s accompanying dot-plot likely to be parsed by observers to gauge which way it leans. 

Also read: RBI governor signals no policy change despite inflation dip

Lastly, domestic data on India’s growth momentum (out in October), inflation numbers in the interim and the rupee’s exchange-rate stability will be important factors for policymakers.

We expect RBI’s policy easing to start in December 2024 on the argument that policy needs to be less restrictive as real interest rates rise, rather than any need to respond to economic duress. Macroprudential measures to address excesses in certain segments, including microfinance, retail lending, etc, are likely to continue.