Jan-21 headline inflation at 4.06% is a 16-month low and finally overcomes the worries that Indian economy could get into stagflation. The Jan-21 inflation also represents a 356 bps fall in just 3 months. Needless to say, the bumper Kharif output and expectations of a robust Rabi are beginning to have an impact. Also, the government has initiated key investments in agricultural infrastructure and that has been instrumental in addressing supply chain bottlenecks, tapering inflation further.
One interesting observation in Jan-21 is that the fall in rural inflation is a lot sharper compared to urban inflation. If you look at overall urban inflation it is just down to 5.06% in Jan-21 compared to 5.19% in Dec-20. However, rural inflation has fallen from 4.07% in Dec-20 to a low of 3.23% in Jan-21. In both rural and urban centres, food inflation was the trigger. Urban food inflation fell from 4.08% to 3.36% while rural food inflation fell from 3.11% in Dec-20 to 1.11% in Jan-21. This led to overall food inflation tapering to just about 1.89% for the month of Jan-21.
Economic survey hinted at shifting focus to core inflation
Contrary to market expectations, core inflation did not correct in tandem with food inflation. Core inflation for Jan-21 stayed flat around 5.65%. Since Jun-20, the core inflation has remained above 5.30% and rising. Normally, core inflation level of below 4% is considered ideal to sustain overall inflation target of 4%.
In the case of food inflation, the correlation between food prices and overall headline inflation is obvious. Last year, despite a bumper Kharif and Rabi output, food inflation in Jan-20 touched 13.63%. To get a clear picture of how food inflation has driven headline inflation, look at how the food inflation has crashed from 11.07% in Oct-20 to 1.89% in Jan-21. That is the story of food prices driving CPI inflation lower.
Why did the Economic Survey 2020 focus so much on core inflation. In fact, the Economic Survey went to the extent of acknowledging that core inflation should be the deciding factor of policy in the future, rather than headline inflation. Core inflation represents the residual portion of CPI inflation excluding food and fuel. Core inflation captures the essence that the real issue is not about too much demand but supply shortfalls. That calls for targeted government investments in infrastructure to unlock the supply chain bottlenecks. Clearly, that is beyond just monetary and fiscal policy!
What pushed inflation lower in Jan-21?
The sharp fall in headline inflation is substantially due to tempering of food prices because fuel and core inflation continue to be elevated. Here is what drove the food inflation sharply lower in Jan-21.
• Meat and fish inflation in Jan-21 was lower on a sequential basis at 12.54%. Egg Inflation tapered but remains high in absolute terms at 12.85% in the month of Jan-21.
• Fruit inflation has picked up further in Jan-21 to 4.96% from 2.68% sequentially. The real impact was visible on vegetable inflation which fell from 22.51% in Oct-20 to (-10.41%) in Dec-20 and further to (-15.84%) in Jan-21. That had a huge impact on food basket.
• Pulses inflation tapered to 13.39% in Jan-21 from 15.98% in Dec-20 and a high of 18.34% in Oct-20. Cereals inflation fell sharply to 0.07% in Jan-21 from 0.98% in Dec-20 and has again been a key driver of lower inflation. Sugar dipped to negative inflation at -0.26%
• The food basket has a weight of 45.86% in the CPI basket. Within the food basket, cereals, milk, vegetable and snacks are 61% and these 4 items have been instrumental in driving food inflation, and consequently CPI inflation, lower.
Does this make a difference to the RBI stance?
In the last few monetary policies, growth has taken precedence over inflation in deciding monetary policy direction. Even with lower inflation, RBI has limited leeway to cut repo as rates are at 25-year lows. The good news is that lower inflation will give the RBI justification to sustain its accommodative policy. But don’t miss the fine print of the Economic Survey on core inflation. That is going to be increasingly the metrics on which the RBI and the government will measure long term sustainable inflation going ahead!