On inflation in India, a silver lining of stability
India’s consumer price inflation is finally back within the band — registering a 5.9% year-on-year increase in November.
After treading above the Reserve Bank of India’s (RBI) target range for almost a year, India’s consumer price inflation is finally back within the band — registering a 5.9% year-on-year increase in November. This is good news, though inflation remains too high for policy comfort. Still, there are silver linings: the moderation has been driven by food prices, which typically affect the lowest level of the pyramid the most. The bulk of the fall can be attributed to perishable items such as vegetables, but there are also signs of stability coming back in staples such as cereals and pulses.
RBI’s work on inflation management will continue. While the major downside surprise on inflation does offer room for cheer, elevated core inflation — which typically reflects underlying price pressures — remains, especially in the services segment. For some time, the government’s targeted intervention to curb import price pressures from seeping into domestic inflation has helped a lot. However, we also see limited further fiscal space as a potential constraint for inflation management.
Food inflation remains the dominant driver of volatility in consumer price index (CPI) inflation, despite the sharp pullback in the prices of vegetables and fruits being the key driver of the downside surprise in the November CPI print. While volatility continues to characterise India’s food basket, lost in the noise is the material shift in a fundamental demand-supply dynamic of India’s food basket. Indeed, persistent efforts by the government over the past decade has ensured that India is now self-sufficient in a variety of food commodities, and the demand-supply balance has turned favourable, boosting the country’s farm exports. This move to a structural surplus in most food segments has been the key driving force behind the overall reduced food inflation over the past decade.
The fall in food inflation has been supported by a synchronous decline in international commodity prices, extending from edible oils to metals and crude oil. As concerns over the global growth outlook continue to intensify, the global commodity price cycle should start to move in India’s favour, helping to reduce both the import bill and domestic prices simultaneously. We believe that if crude oil prices continue to remain below $90/barrel for a sustained period, there will be scope for minor price cuts in domestic gasoline and diesel prices in the coming weeks. Overall, the fall in international commodity prices, if sustained, will help the central bank in re-establishing stable domestic inflation over the coming year.
The emerging flashpoint though, is sticky and elevated core inflation. While the fall in global commodity prices might help reduce prices of imported goods, the strong revival in the domestic economy is pushing up services prices. As pricing power returns, firms are likely to try to restore their battered margins via higher prices — a key risk to watch out for in the coming months. However, we note that the persistence of core inflation at elevated levels is as much a function of the government’s fiscal policies as it is a signal of brewing demand-side pressures in the economy.
Macro policies adopted over the past three years suggest the government and RBI prioritised an inflation-smoothing strategy under which fiscal resources were deployed to shield domestic consumers from external price spikes. Now, if fiscal resources are not available, the government will need to replenish its coffers, and is unlikely to pass along all of the decline in international prices to end consumers.
Overall, while there are clear signs that inflation is easing, the price declines are not yet sufficient to move the needle in favour of a pause by RBI. Indeed, we forecast CPI inflation in Q3FY 23 is likely to remain above RBI’s target range for the fourth consecutive quarter and is likely to average 6.7% y/y in FY22-23. The focus on lowering core inflation and eventually guiding CPI back toward the midpoint of the target band means the fight against inflation is not over yet. However, with both CPI and wholesale price index (WPI) inflation falling below 6% in November and the global price cycle turning to India’s advantage, we expect CPI inflation to fall in the coming months, paving the path for RBI to pause after delivering a 25 basis points hike in February, raising the repo rate to 6.50%.
Rahul Bajoria is chief economist, Barclays
The views expressed are personal