Inflation dips to 3.54%, lowest since August 2019
India's inflation rate dropped to a 5-year low of 3.5% in July, below the RBI's 4% target, mainly due to a favorable base effect, not a significant economic change.
India’s benchmark inflation rate fell to a five year low of 3.5% in July , well below the Reserve bank of India’s inflation target of 4% , the first time it has been in that vicinity since August 2019 when it was 3.28%.
To be sure, the sharp fall in inflation from 5.1% in June to 3.5% in July is more a result of a favourable base effect (a higher value in the corresponding year-ago period that magnifies a fall in the current period) than a radical improvement in the inflationary environment. On a sequential basis, inflation increased by 1.4% between June and July .
July’s inflation numbers are pretty much in line with the 3.6% projection by a Bloomberg forecast of economists. In fact, the Monetary Policy Committee (MPC) of RBI had made an upward revision to its inflationary forecast for the quarter ending September 2024 from 3.8% in its June meeting to 4.2% in its August meeting while keeping its annual inflation projection for 2024-25 the same at 4.5%. MPC did not change interest rates or its monetary policy stance which continues to be focused on withdrawal of accommodation.
Independent economists, however, do not rule out a slightly more benign inflationary trajectory going forward barring a major underperformance by the monsoon -- something that currently looks very unlikely.
Most of the fall in inflation is base-effect driven...
The headline retail inflation print, as measured by the Consumer Price Index (CPI), fell from 5.1% in June to 3.5% in July 2024. What explains this sharp fall?
The answer is a favourable base effect. Retail inflation was 4.9% in June 2023 and 7.4% in July 2023. In case of food inflation, especially vegetables, which has been driving the headline number in the recent past, the base effect is even bigger. Food inflation numbers were 4.6% and 11.5% in June and July 2023. This base effect has translated into food inflation falling from 9.4% in June to 5.4% in July. Food items have a weight of 39% in the CPI basket. Vegetable prices went from contracting by 0.7% in June 2023 to growing by 37.4% in July 2023. This has led to a fall in vegetable inflation from 29.3% in June 2024 to 6.8% in July. Vegetables contributed almost one-third to the overall inflation print in June. Barring a fall in inflation for vegetables, fruits and spices and a benign 3% inflation for milk products, inflation continues to remain broadly similar in other food sub-categories. It is 14.8% for pulses, 8.1% for cereals and 6% for meat, egg and fish. In the edible oil category, the 17-month long contraction finally seems to be coming to an end with the contraction in July reaching 1.2%.
...which is expected to dissipate going forward
A look at the past inflation data shows that the favourable base effect will likely dissipate gradually over the September quarter. Headline CPI print was 7.4%, 6.8% and 5% in July, August and September 2023. This is exactly why MPC expects September quarter’s inflation to be 4.4% which is significantly higher than the July number. Inflation is expected to increase further to 4.7% in the December quarter. MPC’s inflation forecast for the quarters ending March 2025 and June 2025 is 4.3% and 4.4% respectively.
In fact, a look at the core inflation number – it measures the non-food non-fuel part of the inflation basket and is therefore immune to seasonal fluctuations – shows that it has bottomed out after reaching the lowest ever level in the current series last month. According to the Centre for Monitoring Indian Economy (CMIE) database, core inflation in July was 3.34% compared to 3.16% in June. This was already anticipated in the August resolution of the MPC which categorically noted “indications of core inflation bottoming out”.
But independent economists expect a more benign food price scenario in the near-term
Neither the base effect coming into play nor core inflation bottoming out eventually were unexpected facts before the release of Monday’s inflation numbers. Does this make the future inflation trajectory completely predictable?
Independent economists seem to disagree with RBI’s assessment here. “ RBI raised the July-September inflation forecast by 60bp to 4.4%. This forecast, we think, assumes no major vegetable price disinflation over the next few months. If the 10% month-on-month fall in vegetable prices in the first week of August were to continue, there could be downside risks to this forecast”, HSBC Chief India Economist Pranjul Bhandari said in a research note issued on August 8. One bp (basis point) is a hundredth of a percentage point.
“Taking today’s data and early price indicators for July into account, we track CPI inflation for August at 3.4% y/y, driven lower in part by a high base. Early price trends suggest food prices are likely to decrease in August, though we acknowledge that the recent trends in vegetable prices have been unseasonally large and difficult to forecast,” said Barclays economists Shreya Sodhani and Amruta Ghare.
The centrality of food inflation in the overall inflationary environment also means that the monsoon’s performance will play a key role in shaping its future trajectory. While overall monsoon rainfall and crop sowing is in surplus so far there is significant regional and temporal skew in rainfall data, as was pointed out in an analysis in these pages.
Industrial activity loses momentum in June
In another set of statistics released on Monday, industrial activity as measured by the Index of Industrial Production (IIP) lost momentum between May and June with growth rate coming down from 6.2% to 4.2%. The loss in momentum between May and June was a result of deceleration in manufacturing (5% to 2.6%) and electricity (13.7% to 8.6%) despite an increase in growth from 6.6% to 10.3% in mining. Manufacturing has a share of 77% in the index. From a use-based classification, the deceleration was across the board with the consumer non-durable category falling into contraction. “The June (IIP) print was well below both our and consensus estimates (Barclays: 5.2%; Bloomberg: 5.4%). The surprise to our forecast came from a larger-than-expected sequential decline in manufacturing”, Sodhani and Ghare said.