Has inflation peaked? Here’s why it might be a low inflation period ahead
Updated: February 17, 2020 1:53:16 PM
Inflation will likely average 6.5% in Q1 2020 and moderate to 4.7-4.6% in Q2 & Q3, and to 2.4% in Q4
By Sonal Varma and Aurodeep Nandi
CPI inflation accelerated further to 7.6% year-on-year (y-o-y) in January vs an already elevated 7.4% in December, higher than expected (Consensus: 7.4%, Nomura: 7.5%). Food price inflation moderated somewhat to 13.6% y-o-y vs 14.1% in December, primarily reflecting a sharp month-on-month (m-o-m) correction in vegetable prices (-9.1% m-o-m) after months of unseasonally high upticks (average in Q4 = 7.8% m-o-m). However the food basket (ex vegetables) continues to show broad-based inflationary pressures. Protein food items rose sharply this month, led by meat & fish (1.5% m-o-m), eggs (2.5%), milk (1.4%) and pulses (1.5%). Oils & fats and spices showed strong pick-ups in prices over the month. Only segment within the food (ex veg) basket showing m-o-m decline are fruits.
Food (ex veg) inflation sharply picked up to a 42-month high of 7.2% y-o-y in January vs 5.7% in December. This is higher than the average rise in January during 2014-16 (0.49%). Fuel & light inflation rose by 3.7% y-o-y in January vs 0.7% in December, in part reflecting a lower base. Core inflation (CPI ex food and beverages, fuel) increased to 4.2% y-o-y in January vs 3.8% in December, primarily reflecting a sharp m-o-m escalation in personal care (higher gold prices) and transport & communication (elevated telecom prices) segments. Seasonally adjusted (sa), “super-core” basket (CPI ex food & beverages, fuel, petrol, diesel and housing rent) rose by 0.69% m-o-m (sa) vs 0.57% m-o-m (sa) in December. Our measure of trimmed mean CPI rose to 4.4% y-o-y vs 3.7% in December.
Industrial production (IP) growth slowed to -0.3% y-o-y in December vs 1.8% in November, lower than expected (Consensus: 1.8%, Nomura: 0.7%). While this comes on the back of an unfavourable base, on a seasonally adjusted basis too, IP growth fell -2.0% m-o-m, partially reversing the gain of 3.8% in November. The relative performance of the sub-components remained unchanged and weak. Intermediate goods output growth continued to lead the pack, growing by 12.5% y-o-y in December versus 17.1% in November. By contrast, output growth contracted in all other segments: capital goods (-18.2% y-o-y in December vs -8.6% in November), infrastructure goods (-2.6% vs -3.5%), consumer durables (-6.7% vs -1.5%) and consumer non-durables (-3.7% vs 2%). The broad-based decline in industrial activity is consistent with our view that growth remains very anaemic.
January marks the peak inflation reading for this year and current trends suggest that it will moderate in February, even though it is likely to remain elevated at over 6%. Data for the first 11 days of February show that vegetable prices have contracted -19.5% m-o-m vs -17.9% last month, which should lower vegetable CPI inflation further. The sharp fall in oil prices following the COVID-19 outbreak and lower gold prices thus far in February should also help. On the flip side, LPG cylinder prices have been hiked by ~20% m-o-m in early February, which will add ~15bps to headline inflation and we expect the food basket (ex veg) to continue to show sticky inflation. Overall, we project inflation to average 6.5% in Q1 2020 and moderate to 4.7-4.6% in Q2 and Q3, and ultimately to 2.4% in Q4.
With the December IP print, we now have a fuller picture of how growth has tracked in Q4, with some early data of high frequency indicators in January. Overall, while there is some improvement in Q4 (relative to Q3) across consumption (cars, two wheeler, tractor sales), industry (manufacturing PMI, cement, coal), and services (services PMI, light commercial vehicle sales) sectors, this is not uniform; external, industry and investment sectors continue to remain broadly lacklustre and crucially, bank credit growth continues to slow. January shows the fragility of this growth momentum—with weakness returning in passenger car and two-wheeler sales, and railway traffic data, even as PMI and electricity production have improved.
Overall, we expect GDP growth to slide further to 4.3% y-o-y in Q4 (from 4.5% in Q3), before staging a weak recovery to 4.5% in Q1 2020 (lowered from 4.7% earlier). India is not directly exposed to the COVID-19 outbreak, but we are concerned that there will likely be indirect spillovers due to weaker global demand. For 2020, we expect GDP growth to remain below trend at 5.4% in 2020, only marginally higher than 4.9% in 2019. In February, RBI opted for unconventional measures to ease financial conditions and boost credit growth in light of high inflation constraining monetary policy space. The MPC will be keenly looking for definitive signs of the inflation trajectory trending downwards as its focus remains on bridging the negative output gap (and not just growth bottoming), and on the financial stability. Given our view that inflation has peaked while growth is likely to disappoint, we continue to believe the next policy move is still a cut; we expect a 25bps repo rate cut in Q2 2020, which could get delivered as early as April.
(Edited excerpts from Nomura’s Asia Insights report, dated February 12. Sonal Varma is chief India economist and Aurodeep Nandi is India economist, Nomura. Views are personal)