Inflation is nearing its peak; expect 50 basis points in cumulative rate cuts in total
September 16, 2020 6:00 AM
In view of more durable damage to growth versus a more transitory shift in inflation, expect 50bps in cumulative rate cuts in total
Food and beverage price inflation abated slightly to 8.3% y-o-y in August vs 8.5% in July (downwardly revised from 8.7%).
By Sonal Varma & Aurodeep Nandi
CPI inflation was unchanged at 6.7% y-o-y in August (Consensus and Nomura: 6.9%), from a downwardly revised 6.7% y-o-y in July (vs 6.9% previously), as the slight moderation in food price inflation was offset by higher fuel and core inflation. Food and beverage price inflation abated slightly to 8.3% y-o-y in August vs 8.5% in July (downwardly revised from 8.7%). On a month-on-month (m-o-m) basis, vegetable prices rose by a strong 4.7% (vs an already elevated 13.8% in July), and prices in the eggs, sugar and beverages categories rose by over 1% m-o-m. By contrast, prices of cereals, pulses and meat & fish decelerated in August. Overall, the build-up of food prices remains materially higher than in past years, although we are seeing the ex-vegetable food basket gradually correct.
Meanwhile, core inflation (RBI core = CPI ex-food & beverages, fuel) rose to 5.7% y-o-y in August vs 5.5% in July (downwardly revised from 5.7%). Within the core basket, there has been a higher m-o-m rise in personal care (2.7% vs an already elevated 1.8% in July) and transport & communication (0.9% vs 2.6% in July) price inflation, reflecting higher retail prices of gold/silver and petroleum products, respectively. In the case of transport & communications, even ex-petrol and diesel, there has been a strong 0.94% m-o-m increase in the index, reflecting higher railway and airfares, two-wheeler prices and internet and mobile charges.
Looking ahead, food supply-chain challenges and commodity prices remain a potential risk for headline inflation. There are reports that heavy rains have led to production losses and have triggered high vegetable prices in retail markets across the country, with expectations of elevated prices in the coming months.
During the first 13 days of September, our index for key vegetable prices rose a whopping 10.8% m-o-m, over an already elevated 4.6% in August. This is problematic as the September-December period typically sees vegetable prices fall seasonally. With an over 6% weight in the CPI basket, unseasonally high vegetable prices could keep headline inflation elevated for a few months longer than our current baseline.
Recall that the current phase of high inflation essentially began from Q4 2019, when unseasonal rains led to some ~27pp build up in vegetable price inflation from September 2019 onwards (vs contraction of 14.3pp in September-December 2018). This contributed to headline inflation sharply picking up from 4% y-o-y in September 2019 to 7.4% by December, and averaging 6.7% through Q1 2020. The sharp uptick in vegetable prices in September risks seeing elevated vegetable prices returning during the winter months this year too, hence, potentially further elongating the period of stagflation.
The disinflationary pressures from the slump in domestic demand have been overshadowed by supply-side shocks and ‘pandemic-centric’ demand-side ones. We find that three segments stand out as major inflation drivers over the last few months: intoxicants and beverages (impacted by higher excise duties on liquor), transport & communication (higher petrol/diesel prices due to higher taxes and rising oil prices) and personal care (mainly due to higher gold and silver prices, which rose by 7% m-o-m and 0.5% respectively in August). In addition, we find the pandemic has triggered a ‘demand elasticity conversion’ within the core basket, i.e. goods and services that were previously demand-elastic (high prices triggers low demand) are gradually turning demand-inelastic (demand persists despite high prices) under restricted mobility conditions. We see this in higher price increases in core categories such as recreational and hobby-related goods (49.1% m-o-m), railway fares (11.5%) and airfares (9.3%), though the latter are still seeing relatively lower transaction volumes. Overall, we believe that core pressures are not as broad-based given that RBI core inflation ex-petrol, diesel, gold and silver, rose by a more subdued 0.3% m-o-m vs 0.6% in July.
Looking ahead, if vegetable prices mirror trends observed in the first half of September through the month, then headline inflation in September is likely to remain close to August’s print. The trajectory thereon remains sensitive to the evolution in vegetable prices over the winter. If the expected price correction kicks in from October, then inflation should moderate close to RBI’s 4% target by December, supported by a favourable base effect. The upside risk to this projection will be an unabated increase in vegetable prices through Q4. Nevertheless, we believe inflation is near its peak, and while vegetable prices may delay the timing, the trajectory is likely to be lower over the next 6-12 months due to easing supply constraints amid still-weak final demand. The current elevated level of inflation, which is well above RBI’s upper bound of 6%, suggests the MPC will pause again in October. However, given more durable damage to growth versus a more transitory shift in inflation, we expect 50bps in cumulative rate cuts in total, with the next 25bps to be delivered at the December policy meeting.
Edited excerpts from Nomura’s Asia Insights (dated September 14)
Authors are Research Analysts, Asia Economics, Nomura Views are personal