The CPI inflation (retail inflation) for December 2022 tapered further from 5.88% to 5.72%. That is 18 bps lower than the Bloomberg consensus, which had pegged CPI inflation for December at 5.90%. Inflation had fallen by 89 points in November, so the cumulative fall in inflation in the last 2 months is 105 bps. Now the CPI inflation is 207 bps lower than the peak level of 7.79% touched in April 2022. December marked the 39th month that CPI inflation exceeded the median target of 4%; but was also the second month that CPI inflation stayed under the RBI outer tolerance limit of 6%. This put less pressure on the RBI in drafting its narrative to the government on inflation.

One can argue that CPI inflation has fallen just 205 bps from the peak while the WPI inflation is down more than 1100 basis points from the peak. However, the WPI inflation is always more sensitive to monetary tightening. Also, the WPI inflation is normally a precursor to CPI inflation, so one can logically expect lower levels of CPI inflation. In December 2022, Food inflation fell by another 48 bps to 4.19% on top of a 234 bps fall in November. In the last 3 months, food inflation has fallen 441 basis points in all. One worry could be that core inflation bounced back to around 6.1%, offsetting the impact of food and fuel prices. With the base rising from December 2021 onwards; all the way to April 2022, there is scope for further tapering of CPI inflation in coming months.

One of the downsides of lower than expected Kharif output is the spike in cereals inflation. For December 2022, cereals inflation stands elevated at 13.79%, with rural cereals inflation much higher at 14.52%. However, there is a positive side to it. Delayed rains have ensured full reservoirs, which will boost the Rabi output. That is already evident in the 25% better wheat sowing acreage this Rabi season. Full year food grain output will still be impacted.

Rural food inflation remains the real challenge

Rural inflation continues to feel pressure on multiple fronts. On a MOM basis, the rural food inflation did fall from 5.22% to 5.05%. Even the headline rural inflation has fallen from 6.09% to 6.05%. However, in the monthly inflation basket mix, rural inflation is sharply higher than urban inflation, putting pressure on rural purchasing power. Here is how.

Out of the headline inflation of 5.72% for December 2022, rural inflation was 6.05% while urban India was just 5.39%. If you look at overall food inflation at 4.19%, rural food inflation was 5.05% while urban food inflation was 2.80%. In short, urban India is getting most of the gains of falling inflation. There are several instances of specific products too. In the food basket, rural inflation is higher than urban inflation for cereals, eggs, fruits and spices.

Rural inflation for fuel, transport and healthcare is lower than urban inflation. However, there are items like clothing, household goods and household services where rural inflation is meaningfully higher than urban inflation. The biggest gap is in the food basket, where the inflation in rural India is much sharper than in urban India.

Core inflation at 6.1% has been even flagged by RBI governor

Core inflation (the inflation excluding food and fuel), which had fallen to 5.9% in October, has bounced back to 6.1% in December. Core inflation is high in rural and urban areas and that is a structural issue. As long as core inflation remains elevated, it is hard for the headline inflation to come down meaningfully. The concerns are best articulated in the savings rate of Indian households falling from 7.3% of GDP in FY21 to 4% of GDP in FY22. This is an outcome of inflation putting a strain on urban and rural household budgets.

The structural nature of core inflation makes it tougher to manage and regulate and that is the key challenge. As another budget comes up in a few days, it is relevant to recap the Economic Survey ahead of Union Budget 2022. It had underlined the imperative need to focus on core inflation above headline inflation. The target has been to keep core inflation around 4%; but core inflation has stayed above 6% for 9 out of the last 13 months.

Data Source: Ministry of Finance Estimates

India’s fiscal policy has often been at cross purposes with the monetary policy. Controlling core inflation is generally a trade-off between government revenues and the larger goal of inflation control. Fighting inflation has a fiscal cost in the form of duty cuts, and a focus on government revenues spikes inflation. Government has to deftly address this dilemma.

Inflation and the food basket in December 2022

Here are some of the major highlights of the food basket story for the month.

• Let us first look at the high protein and high vitamin intake. Meat and fish inflation was higher at 5.13% while eggs bounced from 4.86% to 6.91%. Oils and fats bounced to positive from -0.63% to +0.53%. Inflation in milk and milk products edged higher from 8.16% to 8.51% in December 2022. 
  
   
• Fruits inflation tapered further from 2.62% to 2.00% even as vegetable inflation dipped further into negative at from -8.08% to -15.08% in December 2022. Among other products, pulses inflation bounced from 3.15% to 3.89%, but the real issue with food inflation appears to be stemming from cereals inflation rising from 12.96% to 13.79%. 

Cereals, milk and other proteins remain key food inflation drivers. However, it was the sharp fall in vegetables inflation that brought down food inflation sharply in December 2022. Shorn of the vegetables effect, effective fall in food inflation may not be that impressive.

How does inflation data impact RBI rates trajectory?

RBI now has three positives to start with. US inflation is down to 6.5% so in terms of monetary divergence, the risk is not too high for the RBI. Secondly, the IIP output has bounced back from -4.22% to +7.11% in November. However, IIP has still been too volatile and dependent on the base effect. Thirdly, the CPI inflation has tapered by 15 basis points to 5.72%, which should give comfort to the RBI. Here is what the RBI can be expected to do in the coming couple of months.

1. The February RBI policy may see a respite from rate hikes and the RBI may opt to wait and watch before taking a call on future rate hikes. The US Fed has also adopted a more gradual approach to hiking rates, mitigating the risk of monetary divergence.
   
    
2. However, the RBI is not yet done with rate hikes and it is likely to hike rates by another 50 bps during the year, albeit in two tranches. That should be sufficient to keep inflation at bay.
   
    
3. The February policy may not only see status quo on rates but even the RBI may look to calibrate its language to give an indication on peak rates or, at least, the levels where the interest rates could top out. 

At the end of the day, all these are normalcy assumptions and the deciding factor would still be the headline inflation. For now, core inflation remains a concern.