India's June inflation lower than expected: HSBC

The RBI will be hoping for a stronger policy response from the government to mitigate price risks from weak rainfall.

July 15, 2014 11:55 IST | India Infoline News Service
Inflation was lower than expected in June, driven by weaker food and fuel price inflation. The positive news, however, ends here. The risks to inflation are still on the upside. The progress of rainfall, for one, has been extremely poor. Press reports suggest that food prices are already spiking. This could quickly spillover to core CPI, given elevated inflation expectations. Fortunately, the RBI remains on guard and the new government has been proactive in augmenting domestic food supply. But policymakers will need to remain vigilant against a resurgence of price pressures, HSBC said in its Economics - Data Reactions.

CPI inflation eased to 7.3% y-o-y in June (vs. 8.3% in May). This is the lowest reading for the new CPI series launched in 2011. June inflation was also below market and our expectation of 7.7% and 7.9%, respectively.
The deceleration in the CPI was broad-based. Within food (7.8% y-o-y vs. 9.1% in May), which carries a 49.7% weight in the CPI basket, vegetables drove the decline (8.7% y-o-y vs. 15.3% in May). Meanwhile, fuel inflation slowed further to 4.6% y-o-y (vs. 5.1% in May).
Core CPI (ex food and fuel) moderated to 7.4% vs. 7.7% in May. All components within the core measure fell, with the sharpest decline seen in 'education', 'household requisites' and 'transport & communication'.
Wholesale Price Inflation (WPI), announced earlier today, also surprised on the downside (5.4% y-o-y vs. 6.0% in May) led by weaker food and fuel inflation. Core WPI, on the other hand, rose slightly (3.9% y-o-y vs. 3.8% in May). On a sequential seasonally-adjusted basis, WPI inflation slowed (0.4% m-o-m sa vs. 1% in May).

The latest CPI readings came in below expectations, but the battle against inflation is not over. This is partly because the supply side of the Indian economy remains shackled by weak policies. The outlook for reforms may have improved following elections, but reducing bottlenecks in the economy will take time.

While a steep base from last year in food (vegetable price spike) and fuels (depreciation) should see headline inflation trending lower in the coming months, short-term inflation risks remain elevated and may halt the recent downtrend in prices.

Weak monsoons will be the main worry for the central bank. The progress on rainfall thus far has been extremely poor, with the country as a whole running a deficit of 45%. In fact, some regions in Gujarat have seen practically no rainfall since the start of the monsoon season in June.

The RBI will be hoping for a stronger policy response from the government to mitigate price risks from weak rainfall. On this front, the new government has already taken some measures to augment domestic supply, such as hiking export duties and lowering import duties. The success of these measures is crucial for the central bank.

Another risk stems from the new budget announced last week. Additional spending penciled in by the new finance minister leaves the fiscal stance neutral to slightly more accommodative than the previous year, potentially putting upward pressure on prices.

Finally, given its importance for India, the central bank will want to keep a close eye on oil.

Additional price risks from food and fuel will impact the RBIs decision making, even though it does not have full control over them. This is because, after years of double digit inflation, expectations remain elevated and need to be fully anchored. This is possible by restoring the inflation-fighting credentials of policymakers. While the RBI is bent on achieving its glide path towards 4% CPI inflation in three years, the government has good reason to join this fight. Otherwise, the new government's grand investment plans may end up fighting for a limited pool of domestic savings.

Bottom line
Both CPI and WPI inflation came in lower-than-expected due to weaker food and fuel price inflation. This is positive news. If inflation continues at this rate, the RBI will be able to achieve its target of 8% inflation by year-end. However, risks to inflation including from poor monsoons remain with us and could halt the recent downtrend in prices. This is where the government needs to step in with more fire power.

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