CPI Inflation

Heading lower and looks sustainable too…

The CPI inflation for the month of September came in at 4.31% much lower than the 5.05% reported in August. Over the last 2 months, the CPI inflation has fallen by 176 basis points. This brings the inflation rate largely in tune with the government’s long term goal of keeping retail inflation at around the 4% mark. Here are 3 things to understand about lower CPI…

Driven by Food Inflation…

 For the last few months, food inflation was the actual bane of prices. Over the last 2 months, food inflation is down by nearly 380 basis points. In fact, for the month of September, food inflation at 3.88% is lower than overall inflation and we are seeing this phenomenon after a very long time. This can be partly explained by a good monsoon and expectations of a record Kharif output. But there is also a strong administrative story. The government has cracked down heavily on hoarders and commodity speculators who drive up prices unnecessarily. Simultaneously, the government has also ensured that adequate buffer stocks for food grains and pulses are made available to manage sudden shortages. With the government taking direct control of retail pricing of essential commodities, we could see a further tempering of food inflation. This is evident in pulses inflation coming down sharply to 14% and vegetables slipping into negative inflation. Food is the big story!

Is low inflation sustainable?

 We have seen inflation falling in the past too but it tends to revert back to the 5-6% level. So how is this time different? Firstly, we have had good monsoons after 2 years of drought. Hence the stickiness of food prices should go away. Secondly, the supply side bottlenecks have been largely addressed. That means the ability of food inflation to unduly influence overall inflation stands reduced. The only risk is fuel prices, but with the global stockpiles of oil, it is unlikely to go up sharply any time soon. Thus CPI inflation seems to have finally transcended the base effect. With the infusion of money through OROP and 7CPC absorbed easily, the short term risks to retail inflation are limited. So, inflation may actually be headed lower.

What does it mean for rates?

Rate setting by the MPC could be a slightly more complicated affair. Apart from lower inflation, the MPC also needs to factor in the impact of the US Fed. If the current trajectory of inflation sustains, the MPC may be induced to cut rates by another 25 basis points before the end of this fiscal year. However, that will depend on the IIP growth and the transmission of rate cuts; both of which currently support another rate cut. The good news is that inflation may finally be headed down. Rate cuts may follow as a logical corollary! ©

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