It may be recollected that due to the impact of the lockdown, MOSPI had desisted from announcing the headline inflation for April and May. Instead, when they announced the CPI inflation for Jun-20, the imputed estimates for April and May were also put out. This stickiness of inflation at above 6% could have larger repercussions for the RBI rate policy but we shall come back to that point later.
Food inflation drives headline inflation higher for Jul-20
There are two ways to look at inflation. The first is to look at the break up of rural and urban inflation. The second way is to look at the specific sub-baskets of headline inflation. Let us look at rural and urban inflation for Jul-20. For the month of July, there was a sharp spike in headline inflation for rural and urban India. For example, the rural inflation in Jul-20 increased from 6.34% to 7.04% while the urban inflation was up from 6.12% to 6.84%. As a result, the overall headline inflation was up from 6.23% to 6.93% on a sequential basis.
Within the overall inflation basket, food inflation moved up sharply from 8.72% in June to 9.62% in July. Interestingly, there were some non-food products like personal care effects which saw inflation rising to 13.63% in July while transport & communication saw inflation rising sharply to 9.95%. Fuel inflation remained subdued at 2.8%, which is understandable considering the weak crude oil prices. As a result, the core inflation crossed the 5% mark after a long time.
What were the key drivers of food inflation in Jul-20?
Food inflation is up sharply to 9.62% and that has long been a major concern for policy makers. Not only does food inflation impact consumption patterns, but it is one of the stickiest aspects of inflation and takes time to reverse direction. Here are some of the key drivers of food inflation in Ju-20.
• Meat and fish continued to report elevated inflation levels of 18.81%, nearly 200 bps higher than the previous month on clearly supply bottlenecks.
• While fruits inflation remained subdued, there was a sharp spike in vegetable inflation to 11.29% from just 1.86% in June. The constraints of labour availability and limited transport movement impaired easy availability of vegetables across India.
• Pulses inflation continued to be sharply higher at 15.92% in July and this should see some positive traction after the Kharif numbers come in. Year 2020 is expected to be a bumper year for the production of pulses.
• The other major items of food basket that reported double digit inflation include spices at 13.27% and oils & fats at 12.41%. COVID-19 has badly hit the supply chains across product categories and food has been the most vulnerable.
• There is a scarcity factor playing on certain aspects of inflation. For example, personal effects inflation at 13.63% and transport inflation at 9.95% are clearly being driven by the scarcity effect as the supply has been terribly curtailed in last few months.
Will this impact the RBI rate policy in October 2020?
Will the sharp spike in inflation lead to a postponement in the proposed rate cut by the RBI? Here are a few points to keep in mind.
• RBI set 4% as the desirable level of inflation with a leeway of 200 bps either ways. However, CPI inflation has been above 6% for seven out of the last eight months making the rate cut call extremely difficult for the RBI.
• Despite the elevated levels of inflation in Dec-19 and Jan-20, the RBI had gone ahead and cut rates by 115 bps in two tranches to neutralize the impact of the economic slowdown caused by COVID-19. That leaves limited room for the RBI, especially considering repo rates are already at a 20-year low.
• Real rates in India have gone deeper into negative territory due to the spike in inflation. Bond yields have been tepid around the 5% mark. That makes Indian debt paper less attractive in real terms compared to most developed markets. Further, rate cuts would be a recipe for further risk-off selling in Indian debt.
Unless inflation falls sharply in August, which looks unlikely at this point of time, the RBI may be inclined to give rate cuts a skip in October. That may not please the financial markets but RBI really may not have much of a choice!