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Economy
Inflation
The story remains the same. Headline inflation remains elevated (as expected) with
revisions to April inflation also on the higher side. June inflation was reported at 9.44%;
lower than our estimates of 9.87%. This compares with May inflation of 9.06%. April
inflation was revised to 9.74% from 8.66% and given the trend of the upward
revisions, the June number is also likely to eventually end up close to our estimates.
Manufactured ex-food products inflation continued to stay high at 7.3% compared to
5.5% in June 2010. With the preferred gauge of inflation for the RBI continuing to stay
higher than the comfort level, we expect RBI to raise repo rate by 25 bps on July 26
despite the more-than-expected soft patch from industrial production.
Primary articles move up; effect of hike in fuel prices yet to come but will be dampened
Primary articles inflation ticked up to 12.2% from 11.3% in May. Most of the increase in the index
came from minerals which increased by 27% yoy compared to 11.9% in May, led by crude price
inflation that was at about 47.3%. Food prices on the other hand remained at around 8.4%,
similar to the inflation in May. Effect of the hike in diesel, kerosene and LPG came in only for the
week-ended June 25 and the full effect on the index will be seen in July. Inflation arising out of
this hike, although, may be dampened by base effect due to a similar hike in prices last year
around the same period. Last year, prices were hiked by 5.6% (June 24, 2011 hike: 9.2%) for
diesel, 11.3% (14.6%) for LPG, 35.4% (18.3%) for kerosene. Added to this, petrol price were also
hiked which now is more or less market determined. Given this situation, July inflation for fuel and
power will likely be at current levels due to this base effect.
Manufactured ex-food products inflation at 7.3%
Manufactured products inflation came in at 7.43%, slightly higher than 7.27% in May. The
internals of manufactured products still indicate a significant effect of global commodity prices as
sectors like ’basic metals, alloys and metal products‘, ’chemicals and chemical products‘, etc.
continue to experience high inflation. Despite some recent softening in the global prices of
commodities, we feel that the pace of any further softening would be slack and hence is unlikely
to be of much benefit for domestic inflation dynamics. Textile price index dropped by 1% over
May with raw cotton price index down 23% from a record high in April 2011. However, further
drops could be limited as global stocks are low and there could be some uncertainties developing
over rainfalls in Gujarat, a key cotton producing state. Measures of core inflation continue to
indicate persistence of demand side pressures. Manufactured ex-food products inflation (a metric
closely watched by the RBI) came in at 7.3%, slightly higher from 7.2% in May.
RBI unlikely to change stance in July 26 meeting
We expect the RBI to continue to tilt towards containing inflation rather than nurturing growth.
We expect headline inflation to remain in the 9.5-10% range for the next four to five months and
could also be biased higher given the historical trends of revisions. Thus we hold to our view that
the RBI would increase the repo rate further by 50 bps to 8%, with the first of the 25 bps hike on
July 26. However, there could be a chance that the next 25 bps hike is delayed beyond the midmonetary
policy review meeting in September. This is likely to be dictated by global conditions.
Significant uncertainties have emerged with respect to sovereign debt worries in the European
region and future course of risk conditions could depend on policy steps taken up to resolve the
issues. In the event of a significant risk aversion playing out which leads to a drop in the
commodity prices, RBI’s course of action could be delayed.
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