Another interesting way to look at inflation is via the rural / urban inflation divide. For the last few months, the urban inflation had lagged rural inflation but that trend appears to have changed in Sep-20. For example, in Sep-20, overall food inflation was sharply higher at 10.68%. While rural food inflation contributed 10.6%, urban food inflation was also elevated at 10.94%. This is in contrast to the last few months when the rural food inflation would consistently outpace urban food inflation by over 100 bps.
Core inflation tapers but food inflation spurts
One of the important vectors to measure the colour of inflation is to compare the food inflation and core inflation. Core inflation is the residual inflation that is left in CPI inflation after food inflation and fuel inflation are removed. Core inflation is material because it is normally sticky and does not come down with the cycles. Also, core inflation is indicative of larger fundamental challenges like supply chain issues. That has been the case in the last few months during the pandemic and the resultant lockdown.
If you look at the food inflation chart, it is down from the peak levels of 14.12% in Dec-19. But, on a yoy basis, the food inflation has more than doubled and that is not a good sign. What is also slightly disappointing is that the trend of tapering in food inflation during June and July could not be sustained. However, with the food grain arrivals in the mandis in October, the food inflation could reduce from current levels.
Core inflation is almost 10 bps lower on a mom basis but 5.67% core inflation is still too high by historical standards. Less than a year ago, the core inflation was just hovering below 3.5% and the rise has been rapid since then. Normally, core inflation above 5% is not a good sign.
What drove food inflation higher in Sep-20?
Food inflation is sharply higher in September at 10.68% from 9.05% in August. Normally, prices tend to taper in September ahead of the food grain arrivals in the mandis, but that has not been the case. Let us look at specific items of food products that contributed to food inflation in Sep-20.
• Meat and fish inflation was over 100 bps higher on a sequential basis at 17.60%. Surprisingly, the poor man’s protein also saw egg inflation go up sharply from 10.11% in Aug-20 to 15.47% in Sep-20 and could really pinch budgets.
• Fruit inflation was subdued at 3.2% but still higher than 1% in August. However, vegetable inflation went up sharply to 20.73% in Sep-20 compared to a more sober level of 11.41% in Aug-20. Labour and transport constraints appear to be taking the toll.
• Pulses inflation was flat on a mom basis but still relatively high at 14.67% in Sep-20. Cereals have remained subdued but inflation in Sep-20 has picked up to 4.68% levels, which is not an encouraging signal.
• The inflation in sugar and confectionaries tapered to 2.47% in Sep-20 but oils and fats inflation still remains high at 13.4%.
• Supply chain constraints are also taking its toll on prices of non-food items. For example, personal effects inflation is still quite high at 12.31%, although lower than August. Transport inflation remains elevated at 11.51%.
Will it be rate cut or just accommodative stance?
With the October monetary policy done and dusted, the focus shifts to Dec-20 and Feb-21. As of now, there appears to be limited visibility on rate cuts till the time CPI inflation really tapers below 5%. The only hope for now is that the influx of food grains in October and November from the Kharif harvest will keep prices in check.
Remember, CPI inflation has touched an eight-month high and that is not conducive to rate cuts for now. In the October policy, the MPC signalled that it would keep monetary policy accommodative till the end of 2021. This is a hint that they really do not expect the inflation to taper in a big way by next year.
What does that mean for policy implications? Accommodation in monetary policy will continue. However, accommodation will not come from rate cuts but from liquidity and government spending. Rate cuts can be ruled out for the time being; at least till the time there is a sustained fall in food inflation and core inflation tapers below the 4% mark.