The big question ahead of Aug-20 inflation was whether it would scale above the 7% mark. Fortunately, that did not happen!CPI inflation for Jul-20 got revised lower from 6.93% to 6.73%. In addition, Aug-20 inflation tapered marginally to 6.69%. If you look back at recent data points, CPI inflation has been above 6% for 7 out of the last 8 months. This is surely a matter of concern when you recapitulate that the RBI median target for CPI inflation was 4% with a worst-case upside leeway of 6%.
CPI inflation for Apr-20 and May-20 are imputed but rest of the data is actual. One quick take is that food inflation remains above 9%, but we shall get back to this point in greater detail. Secondly, rural inflation has tapered MOM in Aug-20 while urban inflation is up. If you look at CPI inflation on a sequential index basis, it is actually higher by 70 bps.
Food inflation under stress in Aug-20, but real worry is core inflation
Rural inflation fell to 6.66% in Aug-20 from 6.76% in Jul-20. Urban inflation in the same period was marginally up from 6.70% to 6.80%.While Food inflation was lower for urban areas too, the fall in food inflation was much sharper (9.47% to 9.11%) in rural areas. The concern is that this could have been triggered by income and purchasing power stress in rural areas as COVID cases are rising in villages. If this trend persists, then rural inflation could fall further;with negative repercussions for rural demand.
The one-year charts of food inflation and core inflation are quite telling. Food inflation is up from 5.11% to 9.05%. The spurt in food inflation is despite the record Rabi crop last year and a bumper Kharif expected this year. This inflation can be largely explained by the rural supply chains being disrupted due to the absence of transport and labour.
Core inflation in the last one year is up from 4.02% to 5.77%. Core inflation is the residual inflation after excluding volatile items like food and fuel. A spurt in core inflation is worrying because it is stickier and a lead indicator of the direction of overall CPI inflation.
How specific products impacted food inflation in Aug-20?
Food inflation has tapered from 9.27% in July to 9.05% in Aug-20. However, as we stated earlier, this must be taken with a pinch of salt as it could be indicative of stress in rural India due to rising COVID cases. Here are some drivers of food inflation in Aug-20.
• Meat and fish inflation was 200 bps lower on sequential basis but still high at 16.50%. The commonly consumed eggs showed 10.11% inflation. Clearly, supply bottlenecks and social distancing appear to be taking a toll.
• Fruit inflation remained subdued at 1% but vegetable inflation continues to haunt at 11.41%. The constraints of labour and transport impair the easy availability of vegetables across India.
• Pulses inflation tapered but still high at 14.44% in Aug-20. If Kharif output is encouraging and transport bottlenecks are removed, we could see pulses tapering.
• Inflation in oils and fats also remains elevated at the same level of 12.45% while spices saw some tapering in inflation to 12.34% in Aug-20. Supply disruptions from central India and Kerala kept prices elevated.
• Consumption is yet to get back to normal as most products are still not easily available. For example, personal effects inflation is sharply higher at 14.45% while transport inflation has also spurted to 11.05%. It could be pricing compensation for losses.
What does this hold for Oct-20 and Dec-20 monetary policies?
In our July inflation analysis, we had stated that October rate cut could be a distant possibility as inflation remained uncomfortably high and repo rates are at 25-year lows. That argument still holds.
• CPI inflation was above 6% in seven out of last eight months and RBI has no reason to believe that inflation would taper by year-end. That would imply that October rate cuts are certainly ruled out but even December looks extremely doubtful.
• The bigger worry for the RBI will be core inflation. The way, it has gathered steam in the last one year, it could keep the CPI inflation trajectory flat to higher. RBI may also conclude that rate cuts may not work till the supply chain bottlenecks are eliminated.
• With headline inflation at 6.65% and 10-year G-Secs struggling around the 6% mark, even the long-end real rates are negative. With India still starved for FPI flows, further rate cuts may not be feasible with the current levels of inflation.
It is very likely that the Monetary Policy Committee (MPC) may focus its attention on core inflation rather than headline inflation in its October meeting. That would most likely rule out rate cuts in October, and perhaps, for the rest of this calendar year too!