India: rate hike looms as inflation accelerates further:: JPMorgan

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India: rate hike looms as inflation accelerates further

May inflation accelerates to 9.1 % oya from 8.7 % in April, as manufacturing prices continue their sharp rise Moderation in global commodity and crude prices in May results in a corresponding decline of non-food primary article and energy inflation However, non-food manufacturing inflation (RBI’s proxy for core) rises to 7.3 % oya in May from 6.3 % in April Furthermore, year-on-year growth rates are understating the sequential momentum of core inflation, which is running well into double digits on an annualized basis Inflation is expected to remain elevated in the coming months as producers continue to retain pricing power, expectations remain elevated, diesel price hikes loom and minimum support prices of some agricultural crops experience generous increases We therefore expect the RBI to continue its anti-inflationary stance and hike policy rates by 25 bps on June 16   May inflation accelerates further Inflation continued to surprise on the upside with the May print accelerating to 9.1 % oya (Consensus: 8.7 %) from 8.7 % the previous month. More alarmingly, the acceleration was led by another surge in non-food manufacturing prices (0.9 % m/m, sa), deemed to be a proxy for core inflation by the RBI.   Meanwhile, consistent with preceding months, March inflation was also revised up to 9.7 % oya from an initial print of 9%. More significantly, the revision entailed a sharp increase to core inflation, which was revised up a whopping 120 bps to 8.5 % oya.   As previously indicated (see, “IP moderates but exports rebound strongly and imports surge; RBI likely to hike by 25 bps,” MorganMarkets, June 10), we had expected the RBI to raise policy rates by 25 bps at its upcoming mid-quarterly review, though a pause could not be completely ruled out. With inflation continuing to accelerate in May, underpinned by core inflationary pressures, a 25 bps rate hike on June 16 is now deemed to be even more likely.   Commodity price cool-off in May induces moderation in non-food primary article and energy inflation...   A moderation of global commodity prices in May expectedly induced a moderation in the inflation rates of non-food primary articles (e.g. raw rubber, raw cotton, raw silk) that are most closely tied to global commodity prices. As a result, non-food primarily article prices declined sharply on a sequential basis (- 4.9 % m/m, sa) printing at 22.3 % oya vis-à-vis 27.3 % a month ago. Given that commodity prices have inched up since their May lows, it is unlikely that June inflation would benefit from a similar dynamic. Similarly, despite an 8% hike in the administered prices of gasoline in mid-May, energy inflation in May also moderated on a sequential basis (-0.5 % m/m, sa) to print at 12.3 % oya versus 13.3 % a month before. This is primarily because abating crude pieces in May resulted in the unregulated components of the energy basket showing a moderation in their rates of inflation. However, with crude prices firming up again, one cannot bank on this trend sustaining. Furthermore, with increases in the administered prices of diesel expected soon, energy price inflation is expected to accelerate in the coming months. In contrast, primary food, although moderating on a year on year basis, increased sharply on a sequential basis (1.5 % m/m, sa), the second consecutive month of a sequential increase. With minimum support prices of key agricultural crops recently increased (see below), food inflation could be pressured further in the months to come.   ...but core inflation continues to surge   The most salient aspect of today’s inflation print, was the fact that non-food manufacturing (core) prices again surged in May (0.9 % m/m, sa) on the back of successive sequential surges in February and March. On a year-on-year basis, therefore, core inflation rose to 7.3 % from 6.3 % the previous month. But despite the increase, year-on-year inflation rates are still significantly understating the current momentum of core inflation. Specifically, until March (the last Month for which we have revised inflation prints), the sequential momentum of core inflation had risen to 13.5 % q/q/, saar, up from 7.9 % q/q, saar just three months prior. Since we don’t have revised inflation numbers for April and May, comparing them to the revised prints of earlier months, runs the risk of significantly understating the sequential momentum, especially because March core inflation was revised up by a whopping 120 bps. However, if April and May are assumed to be revised up by approximately the same quantum, the sequential momentum observed up to March (13.5 % q/q/, saar) would broadly extend up to May.   Apart from the quantum of the increase, it is important to note that manufacturing prices rose across the board, with a majority of sub-groups showing a sharp price increase. What this suggests is that demand continues to be strong enough for producers to retain significant pricing power.   Inflation likely to remain elevated over the next few months…   What’s more, as we have been repeatedly emphasizing, inflation is expected to remain elevated in the coming months. The reasons are not hard to see.   First, despite some high-frequency indicators (motor vehicle sales, PMI) suggesting that the economy may be slowing, more recent data (surging exports and non-oil imports, solid indirect tax collections in the first two months of this fiscal) suggests that demand continues to be strong. More importantly, from the standpoint of inflation, May’s core inflation surge suggests that demand is at least strong enough for producers to retain significant pricing power.   Second, inflationary expectations continue to stay elevated. The RBI’s latest survey of household expectations (conducted up to March and just released) shows that households expect inflation to rise further by another 120 bps compared to their current perceived rate.   Third, increases in administered prices of diesel are long-overdue, and are expected to occur in the coming weeks (government authorities indicated just today that a decision on these prices will be taken soon). While authorities have been pushing this back in the hope of crude pieces moderating, it is hard to see how authorities would even come close to their fiscal deficit targets without some increases in the administered price of petroleum products. The impact on inflation of such increases, however, will be non-negligible. For example, even a 10 % increase in diesel prices (the current under-recovery is upwards of 30 %) would have a cumulative impact (both direct and second round impact through higher transport prices) of about 80 bps.   Finally, the government recently announced increases in the minimum support prices (MSPs) to the tune of 8-15 % of key kharif crops. With MSPs typically serving as the floor of open-market prices and with the percentage increase in MSPs of some crops (e.g. rice, corn) this year significantly higher than those of last year, food inflation is expected to be pressured further.   More generally, the hike in the MSPs was justified on account of a sharp increase in input costs in the agricultural sector which, in part, owes its genesis to in the indexation of NREGA wages. The indexation of NREGA wages, in turn, was justified on the basis of high food inflation which continues to be pressured, year after year, by increases in MSPs – thereby reinforcing this vicious circularity of indexing farm wages and prices!       In sum, for all of the reasons indicated above, we expect inflation to remain elevated for the next several months, before beginning to moderate towards the end of the calendar year, in response to a slowing economy assuming the targeted fiscal consolidation proceeds broadly on track.   RBI likely to hike by 25bps on June 16   As we had indiacted post the IP and exports data release (see, “IP moderates but exports rebound strongly and imports surge; RBI likely to hike by 25 bps,” MorganMarkets, June 10), we believed the RBI would continue with its inflationary-stance and increase policy rates by 25 bps, even though a pause could not be completely rued out.   Today’s inflation print makes a rate hike even more likely. Not only do headline and core inflation continue to accelerate, it is clear that demand is strong enough for producers to retain significant pricing power. With May export data surprising sharply on the upside and indirect tax collections continuing to remain buoyant, activity is likely stronger than commonly thought. With the central banks of China and Korea tightening monetary policy over the last three days, we expect the RBI to follow suit and tighten monetary policy by hiking the repo rate by 25 bps on June 16.