Economy – Inflation- Food-fed inflation; bracing for the hike:: Anand Rathi

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Economy – Inflation
Food-fed inflation; bracing for the hike
As expected, food prices fed inflation in Dec ’10. Although part
of the recent flare in inflation may reverse, we do not expect it at
RBI’s “comfort zone” (4-5%) until Nov ’11. Tight monetary
policy stance is likely to continue in CY11, with the first rate hike
coming in the Jan ’11 Monetary Policy.

 WPI inflation hardens. In line with our estimate, headline
inflation based on the wholesale price index (WPI) rose to 8.4%
in Dec ’10 from 7.5% in Nov ’10. The index rose 1.3% mom. For
Oct ’10, WPI inflation was revised to 9.1% from 8.6% earlier.
 Primary article inflation shoots up. After easing to 13% in Nov
’10, the primary article inflation surged to 16.5% in Dec ’10. The
index rose 3.5% mom, the sharpest monthly rise since Nov ’09.
 Food inflation flares, manufactured inflation at yearly low.
After sharply dipping in Nov ’10 to 9.4%, inflation for primary
food articles jumped to 13.6% in Dec ’10. Despite marginally
softening, yoy inflation for non-food articles, at 22.3% in Dec
’10m, remains high. At 4.5% in Dec ’10, manufactured products’
inflation was the lowest in 12-months.
 Inflation assessment and outlook. The 3M/3M seasonallyadjusted
annualized rate of inflation hardened sharply in Dec ’10.
The diffusion index suggests that prices are broad-based. Our
revised estimates on WPI inflation – 7% in Jan ’10 and ~6% in
Mar ’11 – are nearly 100bps higher than past estimate. The sharp
rise in food inflation in Dec ’10 reflects crop destruction and
supply disruption by rains in Oct-Nov ’10. Improved supply
management is likely to arrest the rise in prices. Interestingly,
despite strong domestic demand, rising input, and labor & interest
costs, low manufactured product inflation seems to suggest that
large global output gaps are capping the tradable prices.
 Policy outlook. The WPI inflation has remained outside RBI’s
comfort zone of 4-5% since Dec ’09. We do not expect the WPI
inflation to revisit this zone till Nov ’11. Despite the sharp drop in
industrial production growth in Nov ’10, concerns on rising
interest costs and lack of investment activities, the RBI is likely to
raise the repo and reverse-repo rates during the Monetary Policy
Review on 25 Jan ’11 in view of the recent flare in inflation. The
continuation of strong liquidity shortage, however, may compel
the RBI to take further measures to ease the liquidity situation