India’s inflation indicators accelerated sharply and somewhat unexpectedly, in Jul-23, largely driven by a spurt in vegetable prices.

• CPI inflation stood at a 15-month high of 7.44% YoY (vs. 4.87% in Jun-23), outpacing market consensus expectation of ~6.4% by a wide margin.
• Despite being in negative territory, WPI inflation too increased to a 3-month high of -1.36% YoY from -4.12% in Jun-23 with the upward pressure from wholesale food prices.
  

Key highlights of Jul-23 CPI inflation

• Sequentially, CPI rose by 2.93% MoM, recording its highest ever monthly momentum in the series.

• The above average seasonal hardening of food prices that started in Jun-23 worsened significantly, led by vegetables, within which tomatoes saw a record jump of ~214% MoM in Jul-23. Vegetable inflation at 37.3% YoY was the highest annualized print since Jan-20. However, price pressures were not just restricted to vegetables with fruits, spices, pulses, and cereals also playing a role.
• Cereals inflation went up further despite the steps taken by the government through the open market auction of wheat and rice through FCI. On a YoY basis, it stood at 13.0% and on a MoM basis, it doubled to 1.2% from 0.6% in Jun-23.
  
• Pulses inflation has continued to firm up at 13.3% YoY, the highest since Jan-21, with elevated prices particularly of tur and urad dal due to a decline in the sowing area in the current season.
• Spices inflation has been in the hot zone for the last one year but has increased further in Jul-23 to a series high of 21.6% YoY and 3.6% MoM. The prices of garlic, ginger and chillies have been particularly on a steep uptrend.  
  
• Consolidated fuel basket rose by 1.44% MoM, its largest increase in the last 12-months. Bulk of the sequential price increase was driven by electricity tariffs, charcoal, and coal.
  
• Sequential momentum in core inflation (CPI ex indices of Food & Beverages, Fuel & Light, and petrol and diesel items within Miscellaneous basket) increased to 0.39% MoM in Jul-23 from 0.06% in Jun-23. The increase in momentum reflects moderate seasonality impact, with the annualized inflation under this category decelerating to a 21-month low of 5.2% YoY.

Key highlights of Jul-23 WPI inflation

• Sequentially, WPI rose by 1.95% MoM, recording a 15-month high momentum.

• The sequential jump was predominantly on account of the consolidated Food & Beverages index that clocked a series high momentum of 6.91% MoM.
•  In comparison, the consolidated Fuel index saw a moderate increase of 0.21% MoM, after declining consecutively for three months.
  
• In contrast, core WPI (Headline WPI ex indices of Primary: Food, Mfg: Food, Mfg: Beverages, Fuel & Power, and Primary: Crude Petroleum & Natural Gas) continued to see a contraction on both monthly as well as annualized basis.
  
  

Outlook on CPI inflation

Climate risks in the form of irregular weather and rainfall patterns  (and pest attack in few cases) along with a pick-up in global food inflation resulted in domestic food prices presenting an absolute shocker over Jun-Jul 2023.  The month of Aug-23 is unlikely to offer any major solace. While tomato prices have begun to correct (~19% down from its recent peak), it could take another month for the downward momentum to gain pace. Moreover, staples like cereals and pulses are unlikely to offer relief in the near term amidst the hardening of international prices and subdued sowing progress domestically. This raises the likelihood of inflation remaining above 7% in Aug-23. 

Moving beyond Aug-23, food inflation pressures could recede gradually as kharif output starts coming on board (a sharp mean reversal in tomato prices over the months of Sep-Nov 2023 is extremely likely, given its short cropping cycle) while drivers of core inflation remain moderate. In the interim, we expect administrative interventions by the government to intensify further to curb price pressures for select food items.

This should help push headline inflation below the upper tolerance threshold (of 6%) from Q3 FY24 onwards. Having said so, the anticipated disruption to the inflation trajectory in Q2 FY23 would pull the average inflation for FY24 upwards. As such, we now revise our FY24 CPI inflation forecast to 5.6% from 5.3% earlier.

Although this is marginally higher than RBI’s recently revised CPI inflation forecast of 5.4% in Aug-23 policy review, we do not anticipate any monetary policy action from the MPC in the current fiscal year as:

• Bulk of the upward revision to full year inflation forecast is on account of the food price shock in Q2, which though extremely impactful on headline inflation, is likely to be transitory.
• Share of number of items within the CPI basket with annualized inflation of above 6% stood at 34.1% in Jul-23. This is the lowest in last 26-months and does not yet reflect any signs of broad-based price pressures.
•  Core inflation has aligned with its series average of ~5%. Expectation of a moderation in GDP growth post Q1 FY24 should help keep core inflation stable.

As such, we expect the MPC to continue to look through the transitory vegetable price shock and extend its pause on repo rate through the course of FY24. This, nevertheless, is likely to be accompanied by a hawkish tone to signal commitment towards inflation management, as we have noted in the MPC meeting of Aug-23 where an incremental CRR (ICRRR) has been mooted to absorb excess liquidity arising from the return of Rs 2000 bank notes. In the event of inflation staying elevated for longer (a low probability event in our opinion for now) due to shift in underlying drivers, the MPC may consider an insurance hike to guard against generalization of price pressures.

Says Suman Chowdhury, Chief Economist and Head – Research “CPI headline inflation in July-23 has provided a shock and surged massively to 7.4% from a revised print of 4.87% in Jun-23. While a significant increase was anticipated given the sharp rise in vegetable prices, this has been far higher than expectations. This is the first time the headline inflation has broken above 7.0% since Apr-22 and is driven by a double digit 11.5% print in food inflation inclusive of a 37% YoY inflation in vegetables. However, this needs to be looked into from the perspective of the transient nature of such price surges.

Given such elevated vegetable prices and to an extent the higher prices of pulses, spices and cereals, the average headline inflation in Q2FY24 is likely to be even higher than the 6.2% forecast by RBI. Accordingly, we have revised our full year CPI inflation forecast to 5.6% in FY24.   

Nevertheless, in our opinion, higher levels of vegetable prices are unlikely to sustain beyond Nov-Dec’23 and food inflation should moderate after 2-3 months, given the shorter crop cycle in vegetables along with the supporting steps to cool prices expected from the government. Also, the core inflation has been around 5% in the month and is yet to be show any effect of the higher food prices. Unless the headline inflation holds up well above 6.0% for the next two quarters, the likelihood of which is low at this point, we believe that RBI will continue with its pause stance for an extended period till end of FY24 while watching the growth-inflation dynamics with a hawkish eye.”

Table1: Overview of the Components – India Inflation: July, 2023 

Chart 1: Headline and core inflation diverge sharply in July-23