Food inflation remains the challenge
In the CPI basket, the food inflation has remained one of the stickiest aspects. The spike in CPI inflation from 3.28% in Aug-19 to 7.59% in Jan-20 was largely driven by higher food prices. The food inflation chain was first triggered by unseasonal rains in September, which led to large scale crop damage. With weak storage and warehousing facilities, most components of the food basket, especially the most vulnerable products, saw a sharp spike in prices.
Within the food basket, vegetables and pulses continue to be the real thorn in the flesh. Food inflation for Jan-20 continues to hover at 50.19%, which is surprising because the government has put in adequate efforts and also encouraged imports of onions to balance the demand supply equation. Pulses at 16.71% inflation also present an unsustainable problem on the inflation front. Even other products like eggs, meat and fish are now experiencing inflation above 10%. The overall food basket inflation was marginally lower at 13.63%, but any hopes of tempering of CPI inflation can be virtually ruled out till the time food inflation is brought under control. The government has shown urgency by allocating funds to post-harvest infrastructure but these are more of medium term solutions. The only hope is that a bumper Rabi output (already 9.5% higher) could partially compensate for the Kharif shortfall.
Other aspects of the inflation basket
While the food inflation in Jan-20 has come down marginally to 13.63% from 14.19% in Dec-20, the question is what exactly drove up the overall inflation. Clearly, oil has not contributed much to inflation because global crude prices have been under pressure due to the impact of the Coronavirus pandemic and risks of a US glut. Therefore, we can logically assume that that spurt in inflation has come from core inflation (inflation excluding food and fuel). This is the portion of inflation that had been under control for the last few months and the government needs to ensure that that does not go out of control in the midst of efforts to bring down food inflation.
Real challenges are on the policy front
In the last two monetary policies, the RBI had maintained status quo on rates due to the sharp spike in inflation. While the RBI has maintained its “accommodative” stance, that could change rapidly if inflation continues to remain at elevated levels. On the domestic front, the RBI has been pushing for banks to cut lending and deposit rates to ensure better transmission. However, beyond a point, low deposit rates just will not work if inflation continues to remain above 7%. At that point, the RBI may not have a choice but to allow repo rates to be hiked again, and we saw in 2018 the consequences of such an action.
The second implication will be on foreign portfolio flows into debt. For a long time, the big attraction of Indian debt was the elevated real returns in the range of 3-4%. However, that has now turned negative. While FPIs were selling Indian bonds through most of December, there was a turn in sentiments post the “accommodative” stance in the monetary policy. But inflation at 7.59% will do little to soothe the nerves of FPIs.
But, there is light at the end of the tunnel!
The good news on the food inflation front is that the Rabi crop has been nearly 9.5% higher than the previous year. The unseasonal rains in September ensured that reservoirs were full and the Rabi sowing season benefited from that. If the Rabi output is actually as good as it is projected to be, it should temper inflation to a large extent. The government is already doing its best in managing supply imbalances and that should also help. Above all, oil prices are likely to remain under pressure because of the lag effect of the Chinese virus pandemic. The US plans to increase its daily output closer to 20mn bpd by end of the year and weak crude prices will keep a check on downstream inflation. Jan-20 inflation may look elevated, but there is surely room for optimism in the months ahead.