JP Morgan: India: honey, it's not just onions!

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India: honey, it's not just onions!

Primary food inflation in surges to 13.6 % oya (7% m/m, sa) in December and headline inflation likely to breach 8% oya Despite the hysteria over onion prices rising 45% oya, weighted contribution of onions to food inflation in December is minimal Instead, food inflation continues to be broad-based with almost all key food groups continuing to show stubbornly high rates of inflation With global commodities continuing to stay high and NREGA wages now indexed to the CPI, prospects for inflation moderating in 2011 appear sober The perception…. Two things were constant through 2010. The first was that primary food inflation raged through the year – staying in the high double digits for all but one month. The second constant was that some tried to explain away this sustained primary food inflation by attributing it to ad hoc, one-off factors that would quickly be reversed. First, we were told that the bad monsoon of 2009 was to blame. Post a good 2010 monsoon, we were told that excessive rains in some parts of the country were responsible for transport disruptions that had resulted in crop not reaching the market. Then we were told that the Commonwealth Games had temporarily caused demand to surge! The implicit assumption in all of these explanations was that the causes were temporary and would soon reverse. December saw no difference. With all four weekly data prints in, primary food inflation for December will print at 13.6% -- a sharp upsurge from the 9.4% witnessed last month. The popular perception seems to be that all of this has been driven by onions, whose prices have soared in recent weeks. Undoubtedly, onion inflation has wide ranging economic and political implications in India. And, undoubtedly, onion inflation has raged in December (45.8% oya, 34.9 % m/m). But, one again, the implicit impression being created is that all of the food inflation for December can be attributed to onions and that since the factors that have kept onion prices high (supply disruptions, possible hoarding and cartelization) will soon be reversed, food inflation will quickly moderate as a result. … and the reality The facts speak quite different. Of the 13.6 % primary food inflation for December, onions account for only 60 bps (accounting for the weight of onions in the primary food basket). That is to say, if onion prices this December were exactly the same as onion prices last December (year on year inflation was 0), primary food inflation for December would still be 13%. Put differently, primary food inflation continues to broad-based with milk, eggs, meat, fish, fruits and other vegetables all contributing in significant measure December’s inflation rate (see chart below) – as has been the case all year long. As we have long argued (see “India: September inflation remains sticky; primary articles are the primary culprit,” October 15, 2010), much of this food inflation is structural reflecting rising incomes in rural areas, changed consumption patterns (i.e. demand for higher protein foods) and the inability of supply to keep up with a sharp increase in demand. Given that increased agricultural productivity and a supply response will take a while, primary food inflation is here to stay! To be fair, onion inflation in December has been very high, and so its contribution to the aggregate inflation rate for December is higher than its weight in the food basket. But that is true of many other food groups as well including milk, eggs, meat, fish, other vegetables and spices. December inflation to print above 8% and it's not just food… As if elevated primary food inflation is not bad enough, non-food primary inflation continues to rage. December will be the third consecutive month that non-food primary inflation will print at higher than 20% oya – driven by elevated global commodity prices. To make matters worse, the momentum of non-food manufacturing inflation has picked up sharply in the last 3 months and, based on sequential momentum, is running at over 8% on an annualized basis. This is no surprise, given that manufacturing capacities continue to be strained, and with food inflation in double-digits for over a year it is a matter of time before food inflation translates into wage inflation. …..and brace yourself: NREGA wages now indexed to inflation If there was any doubt about this food inflation-wage transmission mechanism it was put to rest by the Government itself who announced three days ago that the minimum wages that are paid under the flagship National Rural Employment Guarantee Act (NREGA) scheme would be indexed to the CPI-Agricultural Workers (which have an even higher proportion of food and therefore have had inflation rates higher than the WPI) for each state resulting in an immediate upward revision of NREGA wages by between 17-30%. This move was motivated by the high food inflation of the last year and undoubtedly provides important economic protection to the most disadvantaged. What it also does, however, is to significantly increase the fiscal cost of the program (by 0.1-0.2 % of GDP) and further increase farm costs and thereby add greater pressure to food inflation. Most ominously, however, it may serve to institutionalize indexation of wages across different sectors, with labour in the private sector likely to take their cue from the public sector and NREGA indexation.