Higher Inflation

Why India may not be really staring at higher inflation risk…

The CPI inflation and the WPI inflation did come in sharply higher for the month of October 2017. In fact, CPI inflation came in at 3.58% while WPI inflation came in at 3.59%. This is just about 40 basis points away from the comfort zone of 4% prescribed by the RBI. The key question is what drove up this inflation and what is the outlook for inflation going ahead?

About oil and vegetables

If one looks at the break-up of the 3.58% CPI inflation, the big thrust has come from vegetables. Remember, vegetables had negative inflation for a better part of the last 12 months. In fact, it was vegetables and pulses that contributed most to negative inflation. Hence the impact of vegetables on the overall inflation is being more pronounced. In fact, pulses continue to have negative inflation to the tune of (-23%), but that could change. The anomaly of mandi prices of pulses quoting below the MSP may not persist for much longer. The government has already permitted the free export of pulses and that will reduce the glut in India and push the pulses inflation also higher. Then there is the worry over crude oil. Crude oil has downstream implications and it is already at $64/bbl. With oil market moving to a deficit, inventories shrinking and the upcoming Aramco IPO, one can safely expect oil prices to remain buoyant. That means inflation will feel the upside pressure!

The inflation depressants

At a time when food and oil are pushing inflation up, there are also some inflation depressants. Firstly, the base effect towards the end of the year should help inflation tone down a bit. Secondly, the GST Council has cut the GST rates on 3/4th of the product categories from the peak rate of 28% to 18%. Plus, in some sensitive cases, the rate of GST has even been dropped to 5%. All these are likely to work as depressants of the inflation rate. Thirdly, the rating upgrade by Moody’s could also bring down the cost of funding for domestic and global borrowers and that is likely to result in lower manufacturing inflation. All these could largely neutralize the impact of oil, pulses, and vegetables in overall inflation.

But, will RBI cut rates?

That may be a slightly more complicated question at this point in time. The US Fed action in December and the tax cuts are still hanging under a cloud of uncertainty. That will be critical input before the MPC takes a view on cutting rates in India. At this point in time, the RBI may be keener to ensure that fiscal deficit is in check. That will mean the RBI may not want easy money sloshing around in the system as that will be inflationary. For this calendar year, the RBI may choose to pause in December. The New Year may offer a clearer direction for the RBI! ©

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