Inflation back above 5% but still within RBI comfort zone

Just as the fall in inflation in recent months was led by lower food prices, the spike in headline inflation in Feb-21 was also led by a rebound in food inflation.

Mar 15, 2021 08:03 IST India Infoline News Service

Even before the Feb-21 inflation announcement by MOSPI, consensus estimates of economists had pegged inflation higher. Against 4.06% in Jan-21, the consensus estimate was closer to 4.5% for Feb-21. However, actual headline inflation was sequentially higher by 97 basis points at 5.03% for Feb-21. This negates the falling trend in inflation since it peaked at 7.61% in Oct-20.

Just as the fall in inflation in recent months was led by lower food prices, the spike in headline inflation in Feb-21 was also led by a rebound in food inflation. There is a bigger worry on the core inflation front, which we shall deal with later. The good news is that; despite the 97-basis point spike in CPI inflation, it still remains within the RBI comfort zone of 6% at the upper end.

Data Source: MOSPI

Urban versus rural inflation for Feb-21

For Feb-21, the rural inflation has bounced much sharper than urban inflation. The spike in inflation is caused by the food basket and there could be two possible reasons why rural inflation has spiked. Firstly, fuel inflation added to food prices, trickling through higher transport costs. Secondly, resurgence of COVID cases in last one month has caused supply chain disruptions, giving a cost-push to inflation.

For Feb-21, overall urban inflation was up at 5.96% from just about 5.13% in Jan-21. Overall rural inflation moved up sharply from 3.23% in Jan-21 to 4.19% in Feb-21. However, if you look at food inflation, then urban food inflation is up from 3.36% to 5.63% while the rural food inflation is up very sharply from 1.11% to 2.89%. Spike in rural food prices has been a major driver of food inflation in Feb-21.

Core inflation is becoming an exponential concern

The Economic Survey presented ahead of the Union Budget had highlighted the need to focus on core inflation rather than headline inflation.  Core inflation captures the residual portion of CPI inflation excluding food and fuel. Hence, it would capture the current economic situation perfectly wherein the real issue is not about demand but supply bottlenecks. Traditionally, core inflation below 4% is considered ideal to sustain overall inflation target of 4%, and that is the problem.

Data Source: MOSPI / CEIC

The good news is that food inflation for Feb-21 is still way below the peak food inflation level of 11.07% in Oct-20. To that extent, food inflation has tapered on a structural basis. Core inflation, on the other hand, is surging higher irrespective of the vagaries of food inflation. In fact, core inflation in Feb-21 touched a multi-year high of 5.89% and is 194 bps higher than the Mar-20 levels.

Core inflation is more significant, as pointed out in the Economic Survey, because it is the most intractable component of inflation. Unless core inflation is brought down, it would be tough to sustain headline inflation in the range of 4-5%. Items outside food and fuel are seeing higher price levels, not because of demand expansion but due to supply bottlenecks.

What led to the rebound in food basket in Feb-21?

Since food basket has a significant 45.8% weight in the CPI basket, it is instructive to check what drove the food inflation higher in Feb-21.
  • Meat and fish inflation in Feb-21 was lower on a sequential basis at 11.34%. Egg Inflation tapered but remains high in absolute terms at 11.13% in the month of Feb-21.
  • Fruit inflation has picked up further in Feb-21 to 6.28% from 4.96% sequentially. The real impact was visible on vegetable inflation which had fallen from 22.51% in Oct-20 to (-10.41%) in Dec-20 and further to (-15.84%) in Jan-21. However, for Feb-21, the vegetable inflation was higher at (-6.27%), with the pressure coming from rural India.
  • Pulses inflation tapered to 12.54% in Feb-21 from 13.39% in Jan-21 and a high of 18.34% in Oct-20. Cereals inflation dipped into negative at -0.35% compared 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 -0.70%
  • The food basket has a weight of 45.86% in the CPI basket. Within the food basket, cereals, milk, vegetable and snacks are 61%. Vegetable and milk prices have been specifically responsible for the rebound in food inflation in Feb-21.

Will the RBI look at inflation or at the FOMC?

For the RBI, inflation may not really be a concern as long as the headline number remains under 6%. The concern would be the core inflation components with items like transport, healthcare and personal care product inflation contributing to core sector in a big way. These are all largely driven by supply chain bottlenecks and may continue for now.

RBI would be more interested in what the FOMC does in its next meeting. A dovish stance with a promise of abundant liquidity from the US Fed will give the RBI and the Indian government some breathing space. For now, the FOMC stand and local growth impulses may matter more than inflation numbers.

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