August 2023 CPI inflation tapers to 6.83%, as food inflation falls

13 Sep 2023 , 09:31 AM

When the May CPI inflation had been announced by the MOSPI in at 4.25%, it was a moment of celebration, since India was then just 25 bps away from its inflation target of 4%. Things changed in the next few months. Delayed monsoons, followed by floods in certain parts, played havoc with the production and supply of key items in the food basket as well as with the logistics of supplying these food products to the mandis. The result was runaway food inflation. The prices of cereals, pulses, milk, and vegetables spiked. The first warning was given out June inflation, which spiked to 4.81%, but the real bombshell was dropped in the July inflation, which had surged to 7.44%. In comparison, the August inflation has come in 61 bps lower at 6.83%, although is it still well above the upper tolerance limit of the RBI at 6%. Of course, we are still a good 283 points away from the RBI median inflation target of 4%.

Breathing room for RBI on rate hikes

To an extent, the August inflation was not only lower than the July inflation, but also lower than the Reuters consensus estimate, which had pegged consumer inflation at 7% for August 2023. It may be recollected that at the time of the August 2023 RBI monetary policy announcement, the markets had already factored in a 50% probability of a 25 bps increase in rates by October. However, with the food inflation tapering sharply and headline inflation falling to 6.83%, the RBI may just about have the leeway to hold on till the December 2023 MPC meeting, rather than being forced into a decision in the October MPC meeting itself. The challenge for the RBI is that the US Fed still remains hawkish and even though there are differences within the FOMC, the consensus appears to be a hold in September but an almost certain rate hike in the US in November. Unless the India headline inflation comes down sharply by then, there would be tremendous pressure on the RBI to hike the rates so as to avoid the risk of monetary divergence from the world’s largest central banks.

CPI Inflation tapers by 61 bps in August 2023

Just 3 months back, when the May 2023 inflation had touched 4.25%, it was the lowest level in 25 months. Things have changed a lot in just 2 months with CPI inflation touching a 15-month high of 7.44% in July and still staying well above the RBI outer comfort zone at 6.83% in August 2023. In the last 2 months, food inflation had surged from 2.91% to 11.51%; although it has now tapered to 9.94% in August 2023. The positive takeaway is that core inflation is now below 5%, but headline inflation is still too high for comfort. 

Month	Food Inflation (%)	Core Inflation (%)	Headline Inflation (%)
Aug-22	7.62%	5.90%	7.00%
Sep-22	8.60%	6.10%	7.41%
Oct-22	7.01%	5.90%	6.77%
Nov-22	4.67%	6.00%	5.88%
Dec-22	4.19%	6.10%	5.72%
Jan-23	5.94%	6.10%	6.52%
Feb-23	5.95%	6.10%	6.44%
Mar-23	4.79%	5.95%	5.66%
Apr-23	3.84%	5.20%	4.70%
May-23	2.91%	5.02%	4.25%
Jun-23	4.49%	5.10%	4.81%
Jul-23	11.51%	4.90%	7.44%
Aug-23	9.94%	4.80%	6.83%

Data Source: MOSPI & Ministry of Finance Estimates

Back in April 2022, inflation had made a temporary peak at 7.79%. Since then, the rate of CPI inflation had fallen steadily from 7.79% to 4.25% over the next 13 months. However, the delayed monsoons, followed by deluges in certain parts of India proved to be a double whammy. They not only impacted acreage and output, but also impacted the movement of food to the markets. The result was a spike in inflation across key ingredients of the food basket like cereals, pulses, vegetables, spices, and milk. One can argue that this is more of a cyclical phase due to erratic monsoons, but the fact of the matter is that a lot of the inflation efforts have been neutralized by this spike. It also raises a fresh debate on whether the decision to stop rate hikes was a good decision in retrospect, but that would be like driving looking at the rear view mirror; and macro policy does not work that way.

In the last 2 months; it is not just the cropping output, but also about how soon the supply chains are restored rapidly. Although the inflation in many of the food items have tapered in August 2023, many of the key items in the basket continue to be at inordinately high levels. For example, August vegetable inflation still remains high at 26.14%, spices inflation has spiked further to 23.19%, pulses inflation is almost flat at 13.04% and cereals inflation is still elevated at 11.85%. Even milk inflation stays elevated at 7.75% and the inflation number could have been a lot higher had it not been for the negative inflation in oils & fats and low inflation levels in fruits. Clearly, the essence of the food basket is experiencing unprecedented inflation; which is worrisome. Remember, food still constitutes nearly 50% of the overall CPI inflation basket.

Urban and rural inflation tapered in August 2023

The good news is that inflation is lower across rural and urban centres. For example, headline inflation has fallen from 7.44% to 6.83% between July and August 2023. In this same period, rural inflation fell from 7.63% to 7.02% while urban inflation fell from 7.20% to 6.59%. Let us turn to the food basket. The food inflation overall fell from 11.51% to 9.94% between July and August 2023. In this period, the rural food inflation fell from 11.04% to 9.67% while the urban food inflation fell from 12.37% to 10.42%. The impact has been uniform; with rural and urban India experiencing lower food and headline inflation.

Let us look at some of the key items in the inflation basket and compare the rural and urban scenarios. 

• Let us start with cereals inflation. The overall cereals inflation for August 2023 was at 11.85%. However, rural cereals inflation at 12.23% was much higher than urban cereals inflation at 10.92%. 

   

• Let us now turn to milk inflation. The overall milk inflation for August 2023 was at 7.73%. However, rural milk inflation at 7.86% was higher than urban milk inflation at just about 7.60%.

   

• What about the all-important vegetables inflation? The overall vegetables inflation for August 2023 was at 26.14%. However, rural vegetables inflation at 25.07% was much lower than urban vegetables inflation at 27.87%.

   

• What about pulses inflation? The overall pulses inflation for August 2023 was at 13.04%. However, rural pulses inflation at 12.39% was lower than urban pulses inflation at 14.47%.

   

• Finally, if you look at spices, then the overall spices inflation for August 2023 is at 23.19%. However, rural spices inflation at 23.77% is higher than urban spices inflation which stands at 21.98%.

Among non-food items, inflation in fuel & lighting and in transportation continue to be low on a yoy basis, but that is more due to the base effect. However, fuel inflation is much higher in the urban centres than in the rural areas. Core inflation has trended lower at 4.8%, but that is largely helped along the way by some constriction in consumer demand.

How would the RBI react to the CPI inflation number for August 2023

The August RBI policy marked the third successive policy in which there were no rate hikes. The last rate hike was in February 2023 and the debate on what the RBI does in the October policy is still open. The recent spike in inflation could change the equations of the RBI with respect to future repo rate trajectory. In fact, ahead of the August policy, the market consensus was that there could be a 50% probability of a 25 bps rate hike in the next 2 policies. However, the RBI has held the stance that the food inflation spike was cyclical and should vanish as the food supplies enter the mandis. Here are some takeaways.

1. One thing is clear that with inflation spiking, rate cuts are off the table for the now. If you read through the minutes of the last two policies, the one story that emerges is that the RBI nominated members of the MPC continue to be hawkish even though others are veering towards a neutral stance. It remains to be seen how the tapering of inflation in August is interpreted; albeit still above the upper tolerance limit of the RBI.

    

2. After the July inflation reading at 7.44%, the debate was whether the RBI would really wait till October to hike rates by 25 bps or move quickly to hike rates in the interim period. That looks less likely now and it emerges that the RBI may now risk waiting till December policy announcement to crystallize its view on rate hikes. Whether it happens or not, remains to be seen, but the RBI would want the markets to be mentally prepared for some dose of hawkishness.

    

3. Ahead of the July inflation announcement, the street consensus was already that the inflation would go above 6% in July and August. It has actually been a lot worse. That is likely to make the RBI wary; since the RBI governor has himself admitted that the job of the RBI is not just to ensure price stability but also to manage inflation expectations. FPIs are already getting wary of Indian markets and the RBI would not want a situation where the real rate gap starts to work against FPI flows into India. With inflation at 6.83%, real interest rates in India are already in the negative zone, and that is not a good feeling.

To sum up the inflation impact on rate decisions; the fall in rates in August may give the RBI some leeway to wait and watch, perhaps till December, although that is still a long time away. What the Fed and other central banks do in the interim would also matter to the RBI. But the October policy could at least see the RBI preparing the markets for the possibility of rate hikes. Global central banks are still hawkish despite US inflation coming down and the RBI camp within the MPC wants to front-end rate hikes to dismiss chances of another spike in inflation. It remains to be seen how the navigates these choppy waters.