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. Headline WPI inflation
edged down in November to 7.48% from 8.58% in October in line with consensus
expectations of 7.5% (Kotak estimates of 7.44%). September inflation rate was revised
up to 8.93% from 8.62% earlier. Policymakers would draw comfort from the fact that
the annual inflation rate has fallen to an 11-month low. However, the moderation is
entirely on account of a base effect, as the index jumped by 0.4% m/m.
Protein food-related inflation limiting correction in primary food prices
Food inflation (weighted average of primary food articles and manufactured food products) was at
6.11% from 9.97% in October, the lowest since February 2008. This was due to a positive base
effect, as the food index rose by 0.4% m/m in November 2010 as against a strong 4.1% m/m a
year ago. On the primary food articles side, the annual inflation rate came into the single digit
zone for the first time in 18 months to 9.4%. However, price pressures in protein-rich items such
as eggs (13%m/m), marine fish (3%m/m), and meat (2%m/m) sustained while some dips were
seen in cereals. Manufactured food products inflation decelerated to 0.6% from 3.0% in October
but this was also due to a base effect as the index rose by 1.1% over the month.
Policymakers had hoped that a good kharif output would help bring down food-related inflation.
However, there is a risk that food prices won’t correct significantly even after the kharif output
arrives in the market. (1) Inflation in protein-rich food items remain stubbornly high. (2)
Unseasonal November rains may have damaged parts of kharif crops, such as potatoes and onions
which are showing high rates of inflation. (3) Data suggests that Rabi crop sowing has not picked
up significantly, possibly due to the late kharif harvest and this might have some implications for
rabi output. (4) MSP prices have also risen and would act as a natural floor. (5) Global food prices
remain firm and could spill over to domestic prices.
Non-food inflation continuing to firm up
WPI ex-food ex-fuel moderated only marginally to 9.87% from 10.41% in October, indicating the
presence of more generalized inflationary pressures in the economy. Non-food manufacturing
inflation, which has been closely tracked by RBI to gauge demand-side price pressures, edged up
to 5.4% from 5.1% in October. Higher prices of fibers, logs & timber, raw rubber etc. resulted in
non-food primary articles index rising by 2.5% m/m, taking the annual rate of inflation to 22.6%.
Risks to inflation on the upside; RBI to resume rate hike in 4QFY11E after a December pause
Despite headline inflation falling below 8%, the extent of dip has fallen short of what was being
envisaged by policymakers. In our view, there are upside risks to inflation from (1) domestic food
prices may not correct significantly owing to factors highlighted above, (2) global crude oil prices
have risen sharply to around US$88/bbl, increasing the chances of a fuel price hike (in June when
fuel prices were hiked, oil was trading close to US$75/bbl), (3) prices of other commodities such as
metals have firmed up with excessive liquidity in the global arena and risk a spillover to
manufacturing inflation, and (4) strong demand pull from the domestic economy is evident in the
large current account deficit and there are expectations that domestic demand, especially rural
demand, picks up further. Overall, we expect headline inflation to moderate only gradually to
around 6.0-6.5% by March 2011-end, higher than RBI’s target of 5.5%. On the December 16
mid–quarter policy review, we expect RBI to pause—mainly as it indicated in the November policy
and also as the normalization process of monetary policy is already over, reducing the need to
raise rates at short intervals. RBI could thus afford to pause temporarily but we continue to look at
one last 25 bps increase on January 25, both on the Repo and Reverse Repo rates. With inflation
dynamics staying strong, we do not expect RBI to reduce CRR on December 16.
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