The 100 bps fall in retail inflation came as a breath of fresh air as for the first time in nearly 12 months, the upward trajectory of inflation was halted. When the Fed had made a bold move to cut rates by 50 bps, the RBI chose to wait and watch. With the inflation at 7.59% in Jan-20, the RBI had limited options. The sharp fall in Feb-20 should give some hope for markets that the RBI could replicate a Fed-style stimulus. But, what exactly drove inflation lower in Feb-20?
What triggered the 100 bps fall in CPI inflation?
The 100 bps fall in CPI inflation in Feb-20 over Jan was largely driven by a fall in food inflation. The food price inflation came in at just 10.81% for February compared to 13.63% in the month of January. One key trend that has been seen over the last one year has been that the gap between rural and urban inflation has narrowed. This is partly due to urban stress but also because the series of government programs combined with a good Rabi crop, have been instrumental in reducing rural stress.
If one were to look at the food basket, vegetable inflation continues to be elevated at 31.6%. However, the good news is that it has sobered from the 50% levels that we saw in the last few months. Clearly, the bumper Rabi crop has been helpful in bringing down these prices. The one area of worry continues to be pulses, where the inflation at 16.6% continues to be elevated and is likely to impact consumption patterns in the food basket.
In the inflation basket, the sharp fall in crude prices has not really been passed on to the consumers in the form of commensurate cuts in the price of petrol and diesel. The fact that overall inflation has fallen by just 100 bps despite food inflation falling by 283 bps clearly shows that core inflation (ex-food and ex-fuel) continues to be on a rising trend.
How Feb CPI inflation defines RBI’s monetary options?
- The next RBI monetary policy comes up in early April and hence this will be the last inflation data point before the policy announcement. The RBI clearly has 3 options before it.
- The first option is to wait for a couple of months more of inflation data and also get the first signals of the Southwest monsoon arrival. But that may be too long a wait and the damage to consumer confidence and business confidence may be substantial by then.
- The second option is to take a view on the repo rates at the April credit policy. That will also give more time to the RBI to assess the domestic situation and also watch how the global scenario pans out. That may again be slightly reactive in nature.
- The third option is to bite the bullet and cut rates now. The 100 bps fall in inflation can be trigger enough although the headline inflation still remains above the RBI outer comfort zone of 6%.
How is the RBI likely to react to inflation numbers?
At the end of the day, the RBI decision on rates may be driven by the critical aspect of capital flows into India. Emerging markets, including India, are already seeing a bout of risk-off selling with FPIs selling more than $5 billion in equities in less than 3 weeks. A rate cut at this juncture may open the floodgates for selling in debt too. That could hit the rupee that has already weakened beyond 74/$.
However, in case the RBI chooses to bite the bullet, there are two things that would work in favour of rate cuts. Firstly, the forex chest at $475 billion is hefty enough to prevent any run on the rupee. Secondly, the entire US yield curve is now under 1% and that makes Indian bonds relatively attractive even at current levels. RBI may choose to front-end rate cuts well before the policy. But, considering the global volatility, they will have to act really fast. CPI Inflation at 6.58% may have just provided the trigger!