India: watch out for more aggressive monetary tightening as inflation surges :: JP Morgan

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India: watch out for more aggressive monetary tightening as inflation surges further

March inflation accelerates to 9% oya, significantly above market expectations, from 8.3 % in February January inflation also revised up by a whopping 112 bps to 9.3 % from the initial estimate of 8.2 % Non-food manufacturing (core) inflation surges for a second successive month and is now running at 11% (annualized) on a sequential basis The 1YOIS jumps 20 bps, bond yields rise 5-6 bps and the equity market falls by 1% in response to today’s print With March inflation printing 100 bps higher than the twice-revised estimate of the RBI (8%) and core inflation now in double digits, the RBI is likely to engage in more aggressive monetary tightening; watch out for a 25-50 bps rate hike on May 3 March inflation accelerates to 9% March inflation surprised sharply on the upside, printing at 9% oya (1.4 % m/m, sa) significantly higher than market expectations (JP Morgan 8.4; Consensus: 8.3). The 1Y OIS rose by 20 bps, benchmark government bond yields rose 5-6 bps, the equity market fell almost 1% and the currency depreciated by 0.2% in response to today’s print. The monthly acceleration in inflation was underpinned by another sharp increase in non-food manufacturing prices (1.3 % m/m, sa) as well as surging energy prices (3.5 % m/m, sa). At the same time, January inflation was revised up a whopping 112 bps to 9.3% oya from 8.2%. With each monthly inflation print being revised up retrospectively by between 60-110 bps, a March print of 9% suggests that headline inflation is actually running in double-digits for all effects and purposes Non-food manufacturing prices surge for a second consecutive month Recall, February inflation of 8.3% oya was underpinned by a sharp increase in non-food manufacturing prices (1.6 % m/m, sa). This was not surprising because input costs have exhibited large and sustained increases over the last few months, and with capacities increasingly constrained in the manufacturing sector, it was a matter of time before output prices reacted sharply. What the market was surprised by, however, was another sharp monthly surge of manufacturing prices on the back of last month’s large increase. Most observers had expected some payback to last-month’s increase, but non-food manufacturing prices rose a further 1.3 % m/m. sa – suggesting that inflationary pressures continue to mount sharply. While the year-on-year non-food manufacturing inflation rose to 7 % from 6.1 % the month before, the sequential momentum suggests that non-food manufacturing inflation (what the RBI deems to be core inflation in India) is now running well into double digits (11 % q/q, saar). Equally revealing is the fact that the increase in manufacturing prices was very broad-based, with almost every singly sub-category showing a sharp increase over the previous month. This gives further credence to our view that aggregate demand continues to remain high (especially external demand with manufacturing exports surging over the last 4 months) and capacity constraints are increasingly binding, leading to input price increases being passed on in the form of higher output prices across the board. Energy prices also rise on increased coal prices In addition to manufacturing prices, energy prices also surged 3.5 % m/m (sa) in March. Much of this was anticipated with the increase in coking coal (33%) and non-coking coal (27%) announced in late February, feeding into the WPI index in March. It also reflected sharp increases in the deregulated components of petroleum products (aviation turbine fuel, furnace oil, light diesel oil) in response to the sharply rising crude prices over the last two months. With crude prices showing no signs of letting up, energy prices could continue rising further. Food inflation expectedly moderates in March The only good news in this month’s print was that primary food inflation moderated further to 9.5 % oya (-0.6 % m/m, sa) from 10.6 % oya the previous month and levels of about 15 % a few months ago. This was largely expected the surge in food pieces in December and January was on account of idiosyncratic supply shocks, which have since been reversed. While food inflation could moderate further to the 7-8% levels, we expect it will remain in that range (as has been the case for the most part of the last 5 years) until the structural mismatch between demand and supply is addressed. However, further increases in non-food global commodity prices meant that non-food primary articles continued to rise on a sequential basis, rising 2.2 % m/m (sa) on the back of 4.9 % m/m, sa change last month. With prices of key inputs (raw cotton, raw jute, logs and timber) continuing to show sharp increases, it is a matter of time before this translates into further increases of manufacturing prices. Watch out for more aggressive monetary tightening A year into the monetary tightening process we are right where we started out. March 2010 inflation printed at 10.2 % oya and it is very likely that March 2011 inflation (once revised) will print close to that level. Not only are headline and core inflation significantly above the RBI’s comfort zone, but are actually accelerating on a sequential basis over the last few months. The fact that core inflation is rising sharply and is increasingly broad based, suggests that idiosyncratic supply shocks cannot be blamed for our inflation woes any longer. Instead, as we have been arguing for a long time, if the current inflationary momentum is to be reversed, aggregate demand must be curtailed through more aggressive monetary policy and sustained and credible fiscal consolidation through 2011. Presumably, the RBI’s calibrated approach of 25 bps hikes was predicated on the assumption that March inflation would moderate to 5.5 % (as they had forecast in December 2010). This forecast was revised up to 7 % in January, and further to 8 % in March. When a central bank has to revise its forecast of March inflation by 250 bps in three months, and still end up underestimating the final print by 100-200 bps, it indicates that the calibrated approach to monetary policy is likely not working. Back in January we had indicated that a 50 bps was likely at the RBI’s January review, given the inflationary pressures at the time. While the RBI ended up raising rates by 25bps, the Governor did acknowledge subsequently that a 50 bps rate hike had come up for consideration. Two months later, inflationary pressures and expectations have hardened even further. Core inflation is now running in double-digits on a sequential basis, manufacturing inflation is increasingly broad-based, the risk from crude and global commodity prices remains ever-present, and inflationary expectations continue to harden. As such, we expect that the RBI will likely change course and increase policy rates by 25-50 bps at its quarterly review on May 3.