India’s CPI inflation accelerated sharply to the highest level this calendar year of 5.49% YoY in Sep-24 from 3.65% in Aug-24. While market participants were expecting a surge in headline inflation with a consensus expectation of ~5.1%, the actual outturn posted a sizeable upside surprise.  

Key highlights of Sep-24 data

• On a sequential basis, CPI posted a change of 0.62% MoM. This is somewhat higher than the series median sequential increase of 0.48% in the headline index associated with the month of September. 
• Annualized food inflation rose sharply to a 9-month high of 8.36% in Sep-24 from 5.30% in Aug-24. This increase was on account of an adverse statistical base as well as the sequential build-up of price pressures. 
  1. Sequentially, prices hardened for all major Food & Beverages categories except Spices and Fruits. Edible oils saw a sharp jump on account of a ~20% hike in customs duties (announced by the government to support domestic farm production). In addition, incremental upside price pressures were also seen in Vegetables (esp. garlic, onion, peas, lemon, spinach, etc.) Eggs, Cereals, and Pulses. 
• Consolidated fuel inflation remained in negative territory for the thirteenth consecutive month, albeit inching up sharply to -1.5% YoY from -4.6% in Aug-24 as the impact of favourable statistical base effect faded. On a sequential basis, the index edged up by 0.1% amidst a rise in the price of Coke and Firewood and chips, broadly offsetting the decline in the price of Kerosene and Coal. 
• Core CPI inflation (captured by CPI excluding indices of Food & Beverages, Fuel & Light, and petrol and diesel items within the Miscellaneous basket) rose to 3.8% YoY from 3.5% in Aug-24. The annualised increase was led by Household goods & services, Transport & communication, and most importantly, Personal care & effects (which captured the impact of higher international prices of gold and silver items).

Inference and Outlook

The sharp acceleration accompanied by an upside surprise in headline CPI inflation has raised concerns. 

• While the average CPI inflation in Q2 FY25 stood at 4.2%, marginally higher than RBI’s Oct-24 forecast of 4.1%, it belied expectations of undershooting.
• Food inflation has so far not benefitted from the surplus rainfall in the southwest monsoon season. On the contrary, a skewed rainfall distribution has resulted in price pressures for perishable food items, esp. vegetables, which are sensitive to extreme weather developments. 
• Q2 also saw two sizeable price hikes, the first in the case of telecom tariffs and the other pertaining to an increase in customs duties on edible oils.
• Adverse geopolitical developments in the Middle East, along with policy stimulus in China, have provided a shot in the arm to international commodity prices.

Having said that, there are also silver linings.

• Despite risks, headline CPI inflation averaged at a relatively moderate level of 4.6% in H1 FY25 (with support from deflation in fuel items and record low core inflation).
• The surge in inflation does not appear broad-based. 
  1. Excluding the volatile POT items (Potato, Onion, and Tomato that have a cumulative weight of 2.2% in CPI), inflation stood at a moderate level of 4.2% in Sep-24 vs. 3.5% in Aug-24.
  2. Over the last 12 months, the share of items with 6%+ annualized inflation has dropped from 28.1% in Sep-23 to 23.7% in Sep-24.
  3. The median CPI inflation across all 299 items stood at a subdued level of 2.8% in Sep-24, down from 2.9% in Aug-24.
• The spike in perishable food inflation is likely to be transient. While the sequential price pattern in the case of POT items has overshot its average historical trajectory so far, there is a likelihood of mean reversion from Nov-24 onwards (high-frequency indicators for Oct-24 do not provide any solace yet).
• Kharif sowing in 2024 has come to an end, showing an increase of 1.9% (as of Sep 27) vis-à-vis 2023. With output coming on board gradually from Oct/Nov onwards, one could expect moderation in price pressures for Pulses, Coarse Cereals, and Rice.
• Healthy reservoir levels and the expectation of La Nina supporting rabi sowing should help douse food inflation pressures later in the year.
• Last but not least, we note that Core WPI inflation decelerated to a 5-month low of 0.0% in Sep-24 from 0.6% in Aug-24. This corroborates the lack of pricing power in the manufacturing sector – going forward, this could limit the extent of pass-through to Core CPI inflation.

International crude prices have steadied close to $77.24(Brent crude) after tensions in the Middle East, especially Israel and Iran, had led to a climb.  However, corrections due to the bearish outlook for the global economy are likely. If crude prices reheat to higher levels, India might see an increase in imported inflation due to its dependency for oil. Crude prices are only partly the consequence of Middle Eastern tensions. Security concerns in the Red Sea are making shipping companies reroute around the Cape of Good Hope, causing significant increases in both cost and time. These increased costs might end up affecting core inflation with a lag, resulting in bad news about the inflationary trend.

Overall, while we acknowledge the emergence of an upside risk to our FY25 CPI inflation forecast, we believe that there is still a fair chance of the aforementioned upside risk not playing out. We maintain our FY25 CPI inflation estimate of 4.6%, assuming a strong mean reversion in food prices in the upcoming winter months, along with the absence of further escalation in geopolitical tensions.

From a monetary policy perspective, the anticipated “hump” in CPI inflation (as mentioned by the RBI Deputy Governor Michael Patra) during Sep-Oct 2024 would need a patient see-through. However, it is unlikely to impact the inflation trajectory from Q4 FY25 onwards. Since monetary policy works with long lags, the policy focus should continue to remain beyond the immediate quarter. With downside risks to growth appearing more plausible than upside risks to inflation, we continue to expect the MPC to pivot in the Dec-24 policy review with a 25-bps cut in the repo rate.

Says Suman Chowdhury, Executive Director and Chief Economist, Acuité Ratings & Research, “Headline CPI inflation for the month of Sep-24 has risen more than expected to 5.49% from 3.65% in Aug-24, largely driven by food inflation which rose to 9.24% from 5.66% in the previous month. One of the key reasons for the rise, however, is the base factor, as inflation fell sharply on Aug-23. However, the index has also risen significantly by 0.62% MoM in Sep-24 as compared to nil in the previous month. Sequentially, food inflation has seen a spurt from -0.44% in Aug-24 to 1.18% in Sep-24, keeping the uncertainty on food prices still high. Vegetable prices rose further by 3.49%, while edible oils increased by 2.91% on a MoM basis. Excess rainfall in some parts of the country has been a key factor in driving up food inflation in Sep-24.

Nevertheless, the average CPI inflation in Q2FY25 stands at 4.24%, which is largely in line with the RBI estimates. Needless to say, the food inflation figure will play a critical role in shaping the inflation print in terms of the extent of the seasonal decline in the current quarter after the Kharif harvest. We expect the headline inflation to average at around 4.6% in the third quarter of the year which may enable RBI to go for a rate cut amidst some signs of a moderation in economic activity visible in Q2.”

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: Staple vegetable prices have overshot their historical price build-up

Chart 2: The ~2% increase in kharif sowing should start lowering foodgrain inflation