May 2023 CPI inflation falls materially to 4.25%

13 Jun 2023 , 11:06 AM

There is a sense of irony about monetary policy. As long as the RBI continued to hike repo rates, the inflation was coming down slowly. In February 2023, the RBI effected the last rate hike of 25 bps. However, between February 2023 and May 2023, the consumer inflation has fallen from 6.44% to 4.25%. Of course, it would be inappropriate to say that rate hikes did not matter because what we are seeing today in the form of lower inflation is the lag effect of persistent hawkishness of the RBI between May 2022 and February 2023. During this period, the repo rates were hiked by 250 basis points. That is now showing as the lag effect of the rate hikes. The good news is that May 2023 inflation at 4.25% is not only below the consensus estimates of 4.42%, but also it marks a 2-year low level of inflation. 

Inflation target of 4%, no longer elusive

Since February 2023, the fall in headline inflation from 6.44% to 4.25% has been supported by a sharp fall in food inflation and core inflation. During this 3 month period, the food inflation fell from 5.95% to 2.91%; a fall of 304 basis points. In this period, the core inflation also fell from 6.10% to 5.02%; albeit still high by absolute standards. 

Month	Food Inflation (%)	Core Inflation (%)	Headline Inflation (%)
May-22	7.97%	6.08%	7.04%
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%

Data Source: MOSPI & Ministry of Finance Estimates

Inflation had peaked at 7.79% in April 2022 and has been trending lower since then. The inflation for the month of May 2023 is a full 454 basis points below the peak level of inflation. More importantly, the headline inflation has now come tantalizingly close to the RBI target rate of 4%. Whether that target is reached and sustained remains to be seen, but the start has been encouraging. To a large extent, the driving force for lower inflation has been food and fuel, while core inflation is coming down at a much slower pace.

May 2023 marked the 44th successive month when the CPI inflation has been above the median RBI inflation target of 4%, but the good news is that it is getting close to the RBI target. But, let us focus on the food basket because if CPI inflation has to sustain around 4% then food inflation must remain low. How was the food price situation in May 2023? Clearly, the flow of foodgrains from the Rabi harvest coming into the Mandis has pulled down the prices of foodgrains. Like in the previous month, negative inflation in vegetables, oils & fats and meat & fish have offset the inflation impact. For instance, cereals inflation remains sticky due to weak Kharif output at 12.65%. Among other items in the food basket, spices inflation stays very high at 17.9%. Milk inflation is touching 9% and that has been a major inflation driver. Pulses inflation is moderating, but 2023 Kharif output holds the key.

May 2023 saw rural and urban inflation falling sharply

The interplay between rural and urban inflation is interesting. Till January 2023, it was rural inflation that was hitting prices hard. In February and March, it was the turn of urban inflation to dominate. Since April 2023, both appear to have stabilized and that trend has continued in May also. Let us look at the macro picture first. Between April 2023 and May 2023; overall inflation tapered from 4.70% to 4.25%. During the same period, rural inflation fell from 4.68% to 4.17% while urban inflation fell from 4.85% to 4.27%. What about food inflation? Rural food inflation tapered from 3.89% to 3.19% over previous month while urban food inflation fell from 3.69% to 2.43%. Food prices have fallen much sharper in urban areas than in rural areas.

In terms of specific items in the inflation basket, cereals inflation is still higher in rural India at 13.21% compared to 11.55% in urban India. However, rural India is seeing lower inflation in high protein items like eggs, meat, and fish; although milk inflation is turning higher in rural areas.  The contraction in vegetable inflation is much sharper in urban India at -9.06% compared to -7.61% in rural India. Overall, the food basket showed mixed trends, but the moral of the story is that rural and urban inflation are trending lower.

Core inflation falls materially to 5.02%

Core inflation (inflation excluding food and fuel), which had stayed elevated 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 fell further to 5.02%, although the RBI would prefer to see core inflation closer to the 4% mark. 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%, but that is a long hop as of now, albeit necessary to peg headline inflation at around 4%. While the US economy saw a sharp fall in core inflation even in the US, the core inflation is struggling to decisively fall below the 5% mark, so it does more like a global phenomenon.

Food and fuel are silently killing the inflation monster

While core inflation is still ambivalent, it is food and fuel inflation that are really killing the inflation monster.

• In the food basket, cereals inflation from 13.67% to 12.65%, Oils & fats from -12.33% to -16.01%, vegetables inflation from -6.50% to -8.18% and fruits inflation from 2.09% to 0.70%. However, this did get offset by higher prices of eggs, milk, and pulses. 

   

• The more interest fall is in the fuel inflation represented by fuel & lighting and transport. Both these were in double digits in the earlier part of the year. From that point, fuel & light inflation is down to just 4.64% while transport inflation is down to 1.10%. That can be largely attributed to sharply lower prices of crude. 

To sum it up, the food basket and the fuel basket have really driven inflation lower in May 2023 also. Core inflation is yet to contribute materially to the fall in headline inflation.

Is the RBI preparing for rate cuts?

With inflation at 4.25% and likely to dip further, does this open the sluice gates for the RBI to start cutting rates. After all, at the current levels, the repo rates are a full 135 bps above the pre-COVID repo rate of 5.15%. Here is how the RBI would be thinking.

1. As the RBI has stated in its policy statement, the cut in rates would only be justified if inflation is consistently below 4%. That may be a challenge considering that 2023 is already seeing a delayed monsoons. If the cropping season gets impacted, we could see an eventual impact on food inflation. RBI would be wary of that. 

    

2. Secondly, while the RBI has embarked on rate cuts, it is still aggressively absorbing liquidity from the system through VRRRs. In short, the RBI is still tightening and till then the RBI is unlikely to change its stance to neutral. Any rate cuts would only be conceivable after the RBI officially changes its monetary stance.

In short, rate cuts are ruled out for now and there are 3 reasons for the same. Firstly, a weak Kharif would impact the food inflation negatively. That is something the RBI would watch out for. Secondly, global central banks are still hawkish to neutral and rate differentials are something the RBI would keep an eye on. Lastly, the spectre of a likely global recession is still hanging like a Damocles Sword. In such an eventuality, the RBI would want to keep enough leeway for a dovish policy approach.