India’s CPI inflation moderated to a 4-month low of 5.30% YoY in Aug-21 from 5.59% in Jul-21. While a supportive statistical base has helped, the moderation in annualized headline inflation was also accompanied by softening of sequential momentum - CPI rose by a subdued 0.25% MoM in Aug-21 vis-à-vis 0.74% in Jul-21.

Drivers of Aug-21 CPI inflation

• Food and beverages index remained unchanged in Aug-21 over Jul-21. On sequential basis, month-over-month jump in prices of 7 out of 12 items within the food and beverages basket got offset by decline in prices of the remaining 5 items.
• Price pressures firmed up for Edible oils in Aug-21 after a drop seen in the previous month following government’s reduction of import duties. However, with further duty reduction in the month of Sep-21, sequential momentum can be expected to take a breather for edible oils.
• Meanwhile, sequential price pressures accelerated in case of Sugar & Condiments, Non-alcoholic Beverages, and Prepared Meals & Snacks.
• On the other hand, prices dropped sequentially in case Eggs, Fruits, Meat & Fish, Pulses, and Cereals. For animal protein i.e. egg, fish and meat, this is the first time since the last six months that there has been a sequential contraction in prices.
• Overall, the summer seasonality appears to be somewhat less severe so far on the F&B index. In addition, government measures on incentivizing supplies in case of select food products appears to be having some early impact.
• Fuel and Light index registered a sequential increase of 0.44% MoM in Aug-21, marginally lower than previous month’s momentum of 0.56%. Compared to Jul-21, price pressures decelerated in case of Coke, Coal, Firewood & Chips, Charcoal, Diesel, and LPG. The sub-index of Transport & Communication, within Miscellaneous index also saw a moderation in sequential price pressure on account of Petrol and Diesel. With India Crude Basket stabilizing around USD 70-74 pb range for the last 3-months, further sequential build-up in case of fuel prices is likely to be subdued.
• Core index (CPI ex Food & Beverages and Fuel & Light indices) increased by 0.45% MoM in Aug-21, moderately lower than the 0.76% jump seen in Jul-21. The mild deceleration was led by Housing, Education, and Personal Care & Effects. Meanwhile, sequential price pressure consolidated in case of Clothing & Footwear and Recreation & Amusement categories.
• The pandemic has resulted in stickiness in core inflation due to supply disruption and some evidence of pass through of escalation in input prices. The FYTD (Aug over Mar) build-up in price pressure for core inflation has been at 3.2% in FY22, similar to the level of 3.1% seen in FY21 – this we note is much higher than the average build-up of 2.1% seen in the corresponding 5-year period between FY16-FY20.

WPI inflation: Rises amidst broad based pressure

In contrast to the deceleration in CPI inflation, WPI inflation had a divergent trajectory and inched up to 11.39% YoY from 11.16% in Jul-21. The up-move in annualized rate of inflation was accompanied by a strong sequential momentum of 1.04% MoM in Aug-21 vis-à-vis 0.60% in Jul-21.

• Sequential momentum in food & beverages inflation moderated to 0.19% MoM in Aug-21 from 0.38% in Jul-21. Barring the surge in Apr-21 earlier on account of summer seasonality and lockdown impact, food prices have followed a restrained trajectory so far.
• Consolidated fuel inflation posted another strong sequential print of 1.52% MoM in Aug-21 led by Crude Petroleum & Natural Gas (1.51% MoM), Mineral Oils (2.31% MoM), and Coal (0.31% MoM).
• Momentum in Core WPI (non-food manufacturing) accelerated to a series high of 11.15% YoY in Aug-21. Sequentially, core price pressures rose by 0.72% led by Electrical Equipment (2.19% MoM), Rubber & Plastics (1.41% MoM), Base Metals (1.34% MoM), Textiles (1.30% MoM), Chemicals (1.09% MoM), and Motor Vehicles & Trailers (1.00% MoM).) The continued rise in Core WPI supports our view that with easing of supply side pressures and demand gradually picking up, wholesalers might steadily pass the input cost increases to end customers.

Outlook

Last two consecutive months of CPI inflation has provided comfort.

• First, is the return of inflation to the target band of 2-6% after upside breaches in May-Jun 2021.
• Second, the kharif sowing has been improving. Total area sown for the week ending Sep 10, 2021 is now just 0.9% lower vis-à-vis last year, compared to 4.7% lower for week ending Jul 30, 2021 and 1.8% lower for week ending Aug 27, 2021. Additionally, monsoon performance remains a key monitorable. While rainfall has picked up in Sep-21 recording a surplus of 15% of LPA in the week ended Sep 8, it wouldn’t be sufficient to recoup the overall seasonal deficiency. Nevertheless, the late monsoon revival bodes well for the reservoir levels and in turn rabi sowing.
• After a strong runup, international commodity prices have started to show signs of plateauing amidst supply adjustments in case of oil, administrative actions on select commodities by China, and renewed threat of Covid infections (from the Delta variant) in few countries. This could potentially temper the price impact in the coming months.
• Recently the central government took administrative steps to ease supply in case of pulses and edible oils. At the state level, Tamil Nadu and Puducherry announced a cut in petroleum tax recently. Such policy interventions, scope for which still exists, would be important to calibrate the fiscal-inflation balance.

As such, we continue to stick to our below consensus call of 5.5% CPI inflation in FY22 vis-à-vis 6.2% in FY21. Having said so, we would keep an eye on the stickiness in Core CPI inflation, which could see some spill over from record high Core WPI inflation. With vaccination momentum gathering pace to 8.0 mn doses currently from 4.8 mn in end Jul-21 and 7.4 mn in end Aug-21, we now see India inoculating around 2/3 rd of its population with one dose of vaccine before the end of 2021. This could lead to an upbeat consumer sentiment (as seen in case of few developed economies currently) and lead to some demand side pressures in the near term.

From monetary policy perspective, the comfort derived from moderation in inflation prints in the last two months, reinforces our assumption of continuation of accommodative stance in upcoming MPC meeting in Oct-21. That said, we continue to expect a backloaded normalization if there are strong signs of demand picking up going forward. As such, we expect the RBI to reduce the width of the LAF corridor from 65 bps currently to 25 bps via increase in reverse repo rate by Q4FY22 which will signal a transition from an accommodative to a neutral monetary policy.

Annexure-1

Table1: Key highlights of CPI inflation 

Chart 1: Record Core WPI inflation could pose some risks for Core CPI inflation