India’s CPI inflation eased to a 49-month low of 3.54% YoY in Jul-24 from 5.08% in Jun-24. To be sure, this sharp deceleration was predominantly on account of a favourable statistical base effect, with market consensus expectation for the headline print in Jul-24 remaining in the vicinity of 3.5-3.6%. To recall, the headline inflation had jumped abruptly to 7.4% in Jul-23 from 4.9% in Jun-23 due to a spike in food prices.

Key highlights 

• On sequential basis, CPI rose by 1.42% MoM. This is marginally higher than the series median sequential increase of 1.30% in the headline index associated with the month of July. However, the sequential pressures have been completely offset in the annualised print due to the large base factor. 
• The predominant change in the headline inflation is on account of the Food & Beverages index. Annualized food inflation slipped sharply to a 13-month low of 5.06% in Jul-24. However, this deceleration was on account of strong support from a favorable statistical base. Sequentially, the food price index rose by 2.47% MoM in Jul-24, similar to the 2.69% jump seen in Jun-24. 
  1. Once again, sequential price pressures were led by Vegetables (esp. Tomatoes, Peas, Cauliflower, Onion, Cabbage, Potato, Carrot, Brinjal, Pumpkin, and Radish, all of which saw double digit sequential percentage change in prices).
  2. This was largely on account of lagged impact of the subdued start to the monsoon season along with an uneven distribution of rainfall.
• Consolidated fuel inflation remained in negative territory for the eleventh consecutive month, with a series low print of -4.8% YoY in Jul-24. Incrementally, drop in price of kerosene and coal pulled down the annualized inflation in this category. 
• Core CPI inflation (captured by CPI excluding indices of Food & Beverages, Fuel & Light, and petrol and diesel items within the Miscellaneous basket) reversed its declining trend and moved up to 3.5% YoY in Jul-24 from 3.3% in Jun-24. This was predominantly on account of steep hike in telecom tariffs announced by all the major telecom operators. All other broad categories of core inflation remained broadly stable.

Inference and Outlook

The inflation outcome in Jul-24 has played in line with our expectation of on-boarding of higher telecom charges coupled with persistence of hardness in food prices. With this, most of the incrementally uncomfortable factors now seem to have been incorporated. The sequential inflationary pressure, however, is not reflected in the headline inflation print, which was cocooned by a strong statistical base effect.

It is reasonable to conclude that as the impact of favourable statistical base effect wears off, headline inflation would start climbing back again. While that’s quite likely, we believe the pull back in inflation will be restrained, with headline inflation remaining in the range of 4.5-5.0% in H2 FY25. The following factors would likely contribute towards this outturn:

• South-west monsoon performance has improved in terms of overall rainfall as well as its distribution. As of Aug 12, the cumulative rainfall for the season clocked a 6% surplus (vs. the long period average) compared to a deficit of 11% seen as of Jun 30. More importantly, the skewness observed at the state level has also improved. As of Jun 30, while a cumulative of 16 States/UTs saw rainfall deficiency of more than 20% (vs. the LPA), the tally reduced to 8 States/UTs by Aug 12^th.
• The likely emergence of La Nina conditions from late Aug bodes well not only for the ongoing south-west monsoon season, but also for the upcoming north-west monsoon season later in the year. This will play a supportive role for both kharif as well as rabi sowing.
• As highlighted in our last month’s report, a somewhat restrained increase in Kharif MSPs will have a net deflationary impact of 10 bps in the coming months. In addition, an incremental 5-10 bps of deflationary impact is also likely from the reduction of custom duties on gold announced in the FY25 Union Budget (although, adjusted for the increase in international prices and currency depreciation, the net impact would be miniscule).
• Although global uncertainties continue to persist, international commodity prices (esp. crude oil, industrial metals, and to some extend food) have softened marginally in recent months. Nevertheless, the ongoing disruptions to maritime trade routes in the Middle East region are expected to lead to cost escalations, which could reflect in core inflation with a lag.
• Core inflation may have already bottomed out in the current cycle and may gradually move up to 4.0% not only due to the dilution of the base factor but also on account of steady domestic demand.  

Overall, the lingering impact of pre-election fuel price cuts along with expectation of the respite on food prices would help glide CPI inflation lower towards 4.5% in FY25 from 5.4% in FY24. Having said, we acknowledge the importance of monsoon – less than optimum outcome on this front (not our base case currently) could impart an upside to inflation.

Says Suman Chowdhury, Executive Director and Chief Economist 

“Given the very strong base effect at play, the headline CPI inflation has suddenly dropped to 3.5% YoY from 5.1% in July’24. While the print may give the impression inflation is well under control now, it’s purely driven by the statistical element. Interestingly, there is a significant sequential increase in both food and vegetable inflation in the month of July which has been more than concealed by the annualized decline. 

One important takeaway in the data is the rise of core inflation to 3.5% in July vs 3.3% in Jun’24 on the back of a rise in telecom tariffs. In our opinion, core inflation has bottomed out and is likely to move higher towards 4.0% amidst strong economic activity. 

The strong base factor is set to lower the average CPI inflation print in Q2FY25 to below 4.0% but this is unlikely to sustain in the subsequent quarters. RBI forecasts CPI inflation to increase to 4.7% in Q3 before moderating again to 4.4% in Q4. Caution on food inflation in particular is necessary given the persistence of high food inflation in the last 3 years; it has been higher than 6.0% for 20 months and higher than 8.0% for 12 months in the last 36 months.

We believe that the slightly hawkish narrative in the latest RBI policy has reduced the possibility of a rate cut in the third quarter of the year despite the increased likelihood of rate cuts by US Fed over the next few months. Nevertheless, a shallow rate cut of 25-50 bps by March’25 is still very much in the realms of possibility if there are no fresh surprises on the inflation front.”

Table1: Overview of key sub-components of inflation

Note:

1) CPI-Consolidated Fuel index includes Fuel & Light and Petrol & Diesel indices from the Miscellaneous basket

2) CPI-Core excludes Food & Beverages and Consolidated Fuel indices from Headline CPI

Chart 1: Telecom inflation saw a sharp acceleration on the back 10-25% increase tariffs announced by all the major telecom operators

Chart 2: Despite a slow start in Jun-24, kharif sowing depicts a positive momentum