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Monsoon and inflation: 5 pressure points

Tue Jul 15 2014, 15:32 hrs
Keep an eye on monsoon-led price pressures  Even as the wholesale and retail inflation provided comfort, the next few months will prove to be challenging. Signs of a deficient monsoon and weak acreage have increased the risks of a repeat of the 2009 phase of high food inflation. With uncertainty on inflation trajectory and the fiscal situation remaining precarious, we maintain our call for an extended pause in RBI policy rates. Read Report  (Image Credits: Reuters)
Keep an eye on monsoon-led price pressures

Even as the wholesale and retail inflation provided comfort, the next few months will prove to be challenging. Signs of a deficient monsoon and weak acreage have increased the risks of a repeat of the 2009 phase of high food inflation. With uncertainty on inflation trajectory and the fiscal situation remaining precarious, we maintain our call for an extended pause in RBI policy rates. Read Report

(Image Credits: Reuters)

Phase of comfortable retail inflation
Headline CPI inflation eased substantially in June at 7.3%—the lowest yoy print since the inception of the series. Though the correction was across the board, the largest contributor was moderation in food inflation to 7.9% from 9.2% in May. Broad-based correction in miscellaneous items inflation (comprising education, medical care, household requisites) has largely helped ease June core inflation by ~33 bps to 7.4%. The consistent easing of core CPI inflation indicates that demand-side pressures on inflation are subdued at this point in time. On the other hand, the favorable base effect that kicks in from July could further ease headline and core CPI inflation. (Image Credits: Reuters)
Phase of comfortable retail inflation

Headline CPI inflation eased substantially in June at 7.3%—the lowest yoy print since the inception of the series. Though the correction was across the board, the largest contributor was moderation in food inflation to 7.9% from 9.2% in May. Broad-based correction in miscellaneous items inflation (comprising education, medical care, household requisites) has largely helped ease June core inflation by ~33 bps to 7.4%. The consistent easing of core CPI inflation indicates that demand-side pressures on inflation are subdued at this point in time. On the other hand, the favorable base effect that kicks in from July could further ease headline and core CPI inflation. (Image Credits: Reuters)

With wholesale inflation providing some relief
WPI inflation moved lower in June, printing 5.4% after 6.0% in May. Significant yoy moderation was owing to decline in primary and fuel inflation to 6.8% and 9.0%, respectively, partly helped by a favorable base effect. Within primary articles, food inflation eased to 8.1% from 9.5% in May, but sequentially increased 2.2% led by a sharp acceleration in vegetable prices (16% mom). With incremental news on kharif sowing not too encouraging and vegetable inflation pressures re-emerging strongly, food inflation may be impacted materially in the next few months. Separately, manufactured goods inflation rose marginally in June to 3.61% with core picking up to 3.91% from 3.82% previously. However, the sequential momentum of core has remained comfortable. (Image Credits: Reuters)
With wholesale inflation providing some relief

WPI inflation moved lower in June, printing 5.4% after 6.0% in May. Significant yoy moderation was owing to decline in primary and fuel inflation to 6.8% and 9.0%, respectively, partly helped by a favorable base effect. Within primary articles, food inflation eased to 8.1% from 9.5% in May, but sequentially increased 2.2% led by a sharp acceleration in vegetable prices (16% mom). With incremental news on kharif sowing not too encouraging and vegetable inflation pressures re-emerging strongly, food inflation may be impacted materially in the next few months. Separately, manufactured goods inflation rose marginally in June to 3.61% with core picking up to 3.91% from 3.82% previously. However, the sequential momentum of core has remained comfortable. (Image Credits: Reuters)

Risks of monsoon-led food price surge remain
The upside risk to inflation remains strong with the monsoon yet to pick up in most parts of the country. Risks of drought are increasing as we enter the critical sowing month of July. According to our estimates, July rainfall has ~50% correlation with kharif production. The seasonal rainfall deficit remains at an abysmal 42.6% below normal while the kharif acreage till July 4 is ~43% of last year. The reservoir and basin levels have turned deficient (10% over the last 10 years’ average levels and 34% over last-year level). This removes the comfort of sustaining sowing with lower precipitation level and increases the risks of lower agricultural production. (Image Credits: Reuters)
Risks of monsoon-led food price surge remain

The upside risk to inflation remains strong with the monsoon yet to pick up in most parts of the country. Risks of drought are increasing as we enter the critical sowing month of July. According to our estimates, July rainfall has ~50% correlation with kharif production. The seasonal rainfall deficit remains at an abysmal 42.6% below normal while the kharif acreage till July 4 is ~43% of last year. The reservoir and basin levels have turned deficient (10% over the last 10 years’ average levels and 34% over last-year level). This removes the comfort of sustaining sowing with lower precipitation level and increases the risks of lower agricultural production. (Image Credits: Reuters)

Lower retail inflation may not imply lower policy rates
The inflation prints paint a relatively comfortable picture without any significant uptick in the core inflation. However, we remain cognizant of the inflation risks emanating from (1) resurgence of food inflation on the back of weather uncertainties, which could have significant impact on secondary inflation given higher weight of food in India’s consumption basket and (2) possibility of exacerbating the aggregate demand-supply mismatch and thus inflation expectations if growth picks up in 2HFY15 given the government’s pro-growth policies. The RBI would watch the supply response of the government to combat these inflationary pressures. Given risks of higher price pressures over the next few months, we maintain our call for an extended pause in policy rates. (Image Credits: Reuters)
Lower retail inflation may not imply lower policy rates

The inflation prints paint a relatively comfortable picture without any significant uptick in the core inflation. However, we remain cognizant of the inflation risks emanating from (1) resurgence of food inflation on the back of weather uncertainties, which could have significant impact on secondary inflation given higher weight of food in India’s consumption basket and (2) possibility of exacerbating the aggregate demand-supply mismatch and thus inflation expectations if growth picks up in 2HFY15 given the government’s pro-growth policies. The RBI would watch the supply response of the government to combat these inflationary pressures. Given risks of higher price pressures over the next few months, we maintain our call for an extended pause in policy rates. (Image Credits: Reuters)

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