Major takeaways from the CPI and WPI numbers for Dec 2016

The CPI and WPI numbers for the month of December came in almost at par. While the CPI number came in at 3.41%, the WPI number came in at 3.39%. The gap between CPI inflation and WPI inflation, which was as high as 900 basis points in September 2015, has come down sharply to 0.02% in the month of December 2016…

Key takeaways from the CPI and WPI numbers for December 2016…

  • CPI inflation came in lower at 3.41% for the month of December 2016. The CPI inflation has continued to stay below the RBI comfort level of 5% for almost 4 months in succession now. This gives the RBI much more leeway to take a call on giving interest rate signals through the repo rate mechanism.
  • The sharp fall in the CPI inflation was largely led by food inflation, which fell to a low of 1.37% for the month of December. Food inflation continues to remain below the overall CPI inflation for over 4 months in a row. The lower food inflation was driven by negative inflation in pulses and vegetables on the back of a good monsoon and a bumper Kharif crop which was higher by over 9% on a year-on-year basis.
  • The only worry for policy makers in the CPI number is that the core non-food inflation continues to be sticky. In the previous meeting of the MPC, the members had expressed concern over the stickiness of core inflation and that was also a trigger for not cutting rates in the previous policy. Strong oil and commodity prices have been a key driver for non-food inflation being sticky.
  • The demonetization seems to have had an immediate impact on the inflation and that also seems to be manifesting in the form of lower inflation. While the Kharif crop was much better this year, the Rabi sowing was negatively impacted due to the cash crunch caused by the demonetization drive. That will, perhaps, continue to apply pressure on the inflation numbers in the coming months.
  • The big risk to CPI inflation will be from global oil prices. The price of Brent Crude has already crossed the $55/bbl mark and now looks set to go beyond the $60 mark. Higher crude prices will mean higher landed cost which is not great news for India which depends on imports for 75% of its oil requirement. Oil being core to the demand structure of the Indian economy, higher oil prices can very quickly get transmitted into higher prices across products.
  • WPI inflation has come in slightly higher at 3.39% due to the pressure of higher oil prices. There are 2 trends that emerge with respect to WPI inflation. Firstly, the WPI inflation is finally converging with CPI inflation indicating seamless transmission across the economy. This gap was as high as 900 basis points in September 2015. Secondly, the WPI inflation had stayed in the negative territory for a very long time due to weak oil prices. That trend seems to have decisively shifted in favour of a positive WPI, which is encouraging as that, at least, obviates the risk of the economy slipping into a recession.
  • The big question is whether inflation will come back with growth if the Indian economy emerges out of the demonetization effort rapidly. Initial indications seem to suggest that. The IIP has shown a smart improvement which means that inflation may gather steam sooner rather than later. Also oil prices could increasingly tweak the economics of Indian manufacture and increase the cost leading to a rise in WPI and CPI inflation.
  • Low CPI inflation should ideally encourage the RBI to cut repo rates more aggressively. However, there are some distinct risks. Firstly, there is the upside risk to inflation. Apart from a revival in growth on the back of the end of demonetization, there is also the possibility of oil prices going up sharply from current levels. Due to the strong externalities of oil in an economy like India, the eventual impact on inflation could be much harder. This may force the RBI to think twice before cutting rates in response to lower CPI inflation.
  • CPI inflation may not be the only driver for the RBI to cut rates. The RBI will also want to ensure that the gap between Indian yields and US yields is maintained at an attractive level to dissuade any large scale migration of FPI money out of India and into the US. We have seen the consequences of that policy in 2013 and the government will be extremely wary this time.

In a nutshell, the lower CPI is surely encouraging but the upside risks to inflation cannot be ignored. Core inflation continues to be sticky and one needs to evaluate the impact of oil prices. When the RBI meets in February, it may not be too enthusiastic to cut repo rates; at least not in response to lower CPI inflation alone!

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