Another way to look at inflation is via the rural / urban inflation divide. The feedback that is coming from the IIP growth and corporate results is that a lot of growth traction in the last few months has come from rural India and not urban India. The risk is that it has translated into higher rural inflation. In October 2020, rural CPI inflation stood at 7.69% versus just 7.40% for urban inflation. Thus, rural is contributing more to overall inflation. Even if you look at food inflation, the rural food inflation is now at the same level as urban food inflation; something it had traditionally lagged. In short, higher purchasing power in rural areas due to a bumper Kharif harvest is triggering demand driven rural inflation.
No great news on food inflation or core inflation
What exactly is core inflation? It is defined as the residual inflation after food inflation and fuel inflation are removed from CPI. Core inflation is important to our understanding of prices because it is stickier and does not come down with the cycles. Also, core inflation is indicative of larger fundamental challenges like supply chain and labour stress. Normally, the core inflation should have come down with the production and labour getting back to normal. However, we have again seen the core inflation inch higher in Oct-20. In fact, core inflation has gained 230 bps in the last one year.
If you look at the food inflation chart, it is down from the peak levels of 14.12% in Dec-19. However, if you look on a sequential basis since March, food inflation has been rising month after month. Normally, a bumper Kharif output should have resulted in a sharp fall in inflation but that is not the case this time around, despite a bumper Kharif and Rabi crop.
What triggered food inflation in the month of Oct-20?
What is really worrying about food inflation is the rapid strides on a MOM basis. For example, food inflation moved up from 9.05% in Aug-20 to 10.68% in Sep-20 and further to 11.07% in Oct-20. In short, food inflation had gained 200 bps in just 2 months. Kharif output normally comes into the mandis around end of September but even as late as October, the impact on prices is hardly visible. Here are the specific items of food products that contributed to food inflation in Oct-20.
• Meat and fish inflation was 110 bps higher on a sequential basis at 18.70%. Eggs are an important source of protein for the common man. But Egg Inflation leapt from 10.11% in Aug-20 to 15.47% in Sep-20 and further jumped to 21.81% in Oct-20. That could cause a big dent in most middle class household budgets.
• Fruit inflation has really tapered and has come down sharply from 3.2% in Sep-20 to just 0.34% in Oct-20. Vegetable inflation,even after doubling to 20.73% in Sep-20, inched up further in Oct-20 to 22.51%.
• There seems to be no respite on pulses inflation which has moved up from 14.67% in Sep-20 to 18.34% in Oct-20. There is some respite for cereals as inflation has tapered from 4.68% in Sep-20 to a more reasonable 3.39% in Oct-20.
• The inflation in sugar has tapered further to 1.40% on excess supply but spices remain high at 11.28%. Overall the food basket has some real worries.
• The impact of supply chain constraints is visible on personal effects inflation which is still high at 12.07%, although lower than Sep-20. Transport inflation remains high at 11.16%.
How long can the RBI hold on to accommodative stance?
The Oct-20 Monetary Policy made a brave effort to give guidance of accommodative monetary stance all the way to end of 2021 to boost GDP growth. However, with inflation staying above 6% for 10 out of the last 13 months, RBI has a policy challenge on hand.
While rate cuts are ruled out, the million dollar question is whether the RBI can maintain an accommodative stance. When bond yields are at 6% and inflation is at 7.6%, you have a genuine problem of negative real rates. If inflation does not taper very soon, the RBI may be forced to, at least, begin by withdrawing its accommodative stance. For now, inflation target of 4% does look a long way off!