Consumer inflation dips further for the month of September…

Consumer price inflation for the month of September 2016 was sharply lower at 4.31% as compared to 5.05% in the month of August 2016. It needs to be remembered that in the month of August, the CPI inflation had already shown a sharp fall from the level of 6.07% in the month of July. This sharp fall in inflation can be largely attributed to food inflation coming under control as well as the contribution of the base effect. The good monsoon during the year as well as the expectations of a bumper Kharif crop have been instrumental in bringing down food inflation as well as overall inflation sharply. Here are some key takeaways from the CPI numbers for September 2016…

Lower inflation overall; and that is encouraging…

The overall CPI inflation came in at 4.31% largely in line with the government’s long term target for retail inflation. The fall has been sharp in the last 2 months. In fact, the CPI inflation has come down by 176 basis points in the last 2 months from a high of 6.07% in July 2016 to 4.31% in September 2016. Low CPI inflation is critical for a variety of reasons. Firstly, it brings down inflation expectations, which is a key determinant of long term bond yields. Hence this should result in bond yields coming down further and bond prices appreciating from these levels. Secondly, lower inflation means higher real returns on investment. It also means that the inflation differential between the Indian currency and the US Dollar will come down and that will be able to justify the overvaluation of the INR in terms of REER. Lastly, the launch of GST next year is likely to add 1-2 percentage points to overall inflation. Therefore, it is very essential that pre-GST launch, the inflation level is brought down to the lowest level possible.

Food inflation is the critical number this time around…

Over the last few months, food inflation has been the key driver of inflation in its journey upwards. But food inflation has fallen sharply in the last couple of months. After falling by nearly 241 basis points in August, the food inflation fell by another 121 basis points in the month of September. Interestingly, for the month of September, the food inflation has come in at 3.88%, which is lower than the overall inflation. That means other non-food items are actually exerting pressure on overall inflation. Three reasons have been responsible for a sharp fall in food inflation. Firstly, the normal monsoon this year has been instrumental in bringing down the food prices. More so, since this comes after 2 years of drought! Secondly, the Kharif output this year is expected to be a bumper crop and that is also pulling down food prices. Historically, it is the Kharif crop that has been the key driver of food inflation. Lastly, the government has also done its bit by coming down heavily on commodity speculators and hoarders to ensure that adequate supply is maintained in the market. The government has also been quick to ensure that imports are made available in the event of domestic shortage so that the food prices are kept under control.

A quick look at the break-up of food inflation points out how the overall food inflation has been brought under control. Inflation in pulses which was consistently at above 35% for many months came down to 22% in August and has come down further to 14% in September. That singularly explains the sharp fall in food inflation. Secondly, better supply management has resulted in vegetable prices getting into negative inflation zone.

So what does it say about the RBI rates trajectory?

The million dollar question is what does this mean for rates? The RBI in its last policy in early October had spoken at length about the need to bring inflation and expected inflation under check. This seems to be the first step. More so, since the stickiest component of inflation; food inflation has been substantially tamed. The RBI had cut rates by 25 bps in October and has kept the door open for another 25 bps cut in this financial year. This low level of consumer inflation prepares the perfect set-up for the Monetary Policy Committee (MPC) to go ahead and cut rates further from these levels.  That will surely be the icing on the cake for the financial markets.

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