June 2023 CPI inflation at 4.81%, sharply higher than expected

13 Jul 2023 , 07:31 AM

In May 2023, the headline CPI inflation had touched a multi-year low of 4.25%. From the RBI point of view, the retail inflation was just about 25 bps away from its median target of 4% for headline inflation. In just one month, the picture has changed drastically. Inflation for June spiked to 4.81%. This is in contrast to the street estimates of flat 4.25% inflation in June and the Reuters estimate of headline inflation at 4.58%. Headline inflation is sharply higher than both these numbers.

This also raises questions about any rate cuts in the near future by the RBI or even whether the rate pause can continue for much longer in the light of higher inflation. It may be recollected that the RBI effected the last rate hike of 25 bps in February 2023 before holding status quo in April and June 2023. Between February 2023 and May 2023, the consumer inflation has fallen from 6.44% to 4.25%, which ratified the stand of the RBI. However, in June 2023, inflation has spiked to 4.81%, largely on the back of a spike in food inflation. That was expected in the light of the delayed monsoons on one hand and the spike in the price of vegetables due to supply disruptions on the other. Also core inflation has inched higher in June 2023, albeit marginally. 

Inflation withdraws farther from the RBI 4% target

Between February 2023 and May 2023, the fall in headline inflation from 6.44% to 4.25% was supported by a sharp fall in food inflation. During this 3 month period, the food inflation fell from 5.95% to 2.91%; a fall of 304 basis points. Even core inflation fell from 6.10% to 5.02%; although that is still high by absolute standards. 

Month	Food Inflation (%)	Core Inflation (%)	Headline Inflation (%)
Jun-22	7.75%	5.96%	7.01%
Jul-22	6.75%	6.01%	6.71%
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%

Data Source: MOSPI & Ministry of Finance Estimates

Back in April 2022, inflation had peaked at 7.79%. Inflation for May 2023 was a full 454 basis points below the peak inflation. That gap has reduced in June. Also, in May 2023, the inflation was just about 25 bps away from the RBI mandated median target of 4%. In June, inflation is a full 81 bps away from the target. It can be said that the spike in inflation in June was largely beyond control as it was caused by delayed monsoons. However, it is not just the shortage of rain in some places, but also excess rainfall in other places that has taken its toll on food inflation. Vegetables have been the biggest casualty as crops in Northern India have been badly damaged and supply chains have been disrupted.

Incidentally, June 2023 marked the 45th successive month when the CPI inflation has been above the median RBI inflation target of 4%. The success of monetary policy will lie in keeping the inflation as close to the 4% mark as possible. Thanks to the spike in prices of vegetables, economists apprehend that the food inflation could spike even higher in July and August, unless the supply chains are restored rapidly. 

In the last couple of months, it was the flow of foodgrains from the Rabi harvest coming into Mandis that had pulled down food inflation. This year, the inflation in cereals and pulses is already high in double digits indicating the pressure that prices are under. Now, with vegetable prices also spiking MOM, most of the heavyweight items in the food basket are spiking.

Urban food inflation was the villain of June 2023

Let us look at the macro picture first. Between April 2023 and May 2023; overall inflation tapered from 4.70% to 4.25%. In this period, rural inflation fell from 4.68% to 4.17% while urban inflation fell from 4.85% to 4.27%. That has been reversed in June. For instance, overall food inflation went up from 2.96% to 4.49% in June 2023. Overall, the inflation was higher in urban and rural areas, but the spike in food inflation was higher in urban areas. For example, between May and June 2023, rural food inflation was up from 3.30% to 4.56% while urban food inflation spiked from 2.43% to 4.31%; and that is the pressure point. 

In terms of specific items in the inflation basket, cereals inflation is still higher in rural India at 13.26% compared to 11.56% in urban India. However, rural India is seeing lower inflation in eggs, meat while the inflation for meat and fish is the same and the inflation for milk is higher in rural areas. The contraction in vegetable inflation is much sharper in rural India at -1.20% compared to -0.52% in urban India. But the real crux of the problem is overall vegetable inflation in June 2023 moving from around -9% to less than -1%. This normalization is happening due to the base effect advantage gradually waning away and also because the pressure of vegetables prices is most evident in the MOM numbers.

Core inflation bounces marginally to 5.1%

Core inflation (inflation excluding food and fuel), which had stayed at 6.1% between December 2022 and February 2023, fell to 5.95% in March 2023 and further to 5.20% in April 2023. In May 2023 it had fallen further to 5.02%. In June 2023, the core inflation bounced to 5.1%, although economists estimate that core inflation for June could be anywhere in the range of 5.1% to 5.4%. The challenge with core inflation is that, as long as it stays elevated, it is tough to bring down headline inflation as it is relatively sticky.

The target here is to keep core inflation around 4%, and that is the endeavour of the RBI also. However, that is a long hop as of now, albeit essential to peg headline inflation at around 4%. Core inflation tends to be structural in nature and reflects the stickier side of inflation. It is also reflective of the supply chain constraints in the Indian economy, but we will leave that discussion aside for now.

Food and fuel still hold sway over inflation 

While core inflation is still ambivalent, it is food and fuel inflation that are actually deciding on the direction of inflation. While food and fuel inflation may have spiked in June 2023, they are still the two factors that are determining inflation shifts in the short run. It cannot be refuted that food and fuel inflation are down sharply from the highs of February 2023 and that is the good news. In the month of June, fuel and light inflation fell from 4.64% to 3.92% while transport inflation bounced from 1.10% to 2.48%. However, both are a long way below the double digit levels we had seen in the past one year. Hence in the short term, the inflation driver would continue to remain food and fuel. 

If you look at the food basket story in June 2023, cereals inflation at 12.71% and pulses inflation at 10.53% still remain elevated. Spices inflation continues to remain elevated at 19.19%, although it is a low weight item. Even milk and egg inflation are hovering in the 8% range. But the real thrust to inflation in June came from vegetables inflation spiking sharply on a MOM basis. Food basket has a weight of 45.86% in CPI inflation and within the food basket; cereals, milk and vegetables are nearly 50% of the food basket. The pressure points are all facing higher inflation in the food basket.

Are rate cuts ruled out for now?

In a sense, the RBI governor, even in the June policy speech, had ruled out rate cuts. However, the markets still hoped that the RBI would oblige at some point in the next 6 months. However, with inflation spiking to 4.81% in June 2023 and promising to rise further in July and August, rate cuts may be ruled out in 2023. It is true that the repo rates at 6.50% are a full 135 bps above the pre-COVID repo rate of 5.15%. However, the RBI may not even want to conceive about rate cuts till the inflation story for July and August are known.

As the RBI has stated in its policy statement, the cut in rates would only be justified if inflation is consistently below 4%. That is yet to happen. Also, the RBI has been tightening liquidity through VRRR (variable reverse rate repos); and that shows it has not yet given upon its underlying hawkish intent.

To sum it up, RBI may not be thinking about rate hikes, but rate cuts are ruled out for now. The global central banks are still hawkish despite US inflation coming down to 3%. The RBI camp within the MPC is still not done with its hawkishness. For now, it looks like the RBI camp may prevail in the August 2023 monetary policy.