24 August 2011

India: one step forward and two steps back – July headline inflation moderates but core rises:: JPMorgan,

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India: one step forward and two steps back – July headline inflation moderates but core rises

 
 
  • &#9679 July headline inflation moderates to 9.2 % oya from 9.4 % in June largely on account of softening global commodity prices
  • &#9679 But core inflation accelerates further to 7.5 % oya – its highest level in four months
  • &#9679 The monthly momentum of core inflation also ticks up with a vast majority of sub-groups experiencing price increases – indicative of continued producer pricing power
  • &#9679 Meanwhile May inflation is revised up 50 bps to 9.6%, consistent with retrospective revisions seen in previous months
  • &#9679 With headline and core inflation still significantly above policymakers’ comfort zone, activity stronger than once presumed, and evidence that pricing power still exists, the RBI is likely on course to raising rates again at its September review
 
One step forward: headline inflation moderates as commodity prices soften…
 
Headline inflation printed at 9.2 %oya in July slightly below our expectations (Consensus: 9.2 % oya, JP Morgan 9.4 %) and moderated compared to the 9.4 % print the previous month. That said, core inflation rose to 7.5 % oya – its highest rate in 4 months – and the revised print will likely end up even higher (see fuller discussion below). Furthermore, the disturbing pattern of large retrospective revisions continued with May inflation being revised up by 50 bps to 9.6%, though one can take solace from the fact that the magnitude of the revision was lower than in previous months.
 
The moderation in the July headline print was driven, in large part, by the sustained moderation of “non-food primary articles” whose rate of inflation fell to 15.5 % oya in July (-2.9 % m/m, sa) down from almost 27% a few months ago. This sub-group of the index most directly reflects changes in global commodity prices and its moderation over the last few months reflects the softening of global commodity prices from their April highs.
 
 
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Recall, global commodity prices fell further in the first two weeks of August amidst rising global uncertainty, but have inched back up in recent days. How they evolve over the next few weeks will be a key determinant of the impact of non-food primary article inflation on the headline rate in the coming months.
 
Similarly, the impact of the administered increase in prices of retail petroleum products (diesel, kerosene, LIPG) which was to show up largely in July was offset, to an extent, by the decline in the prices of non-administered components of the fuel basket in response to a slight moderation in crude prices.
 
…but two steps back: core inflation continues to rise and momentum ticks up again
 
However, non-food manufacturing inflation – a proxy for core inflation and something that is closely monitored by the RBI as a sign of demand pressures in the economy – continued to tick up. Specifically, core inflation for July (unrevised) printed at 7.5 %oya up from 7.2 % the previous month and even higher than the revised prints of 7.3 %and 7% observed in May and April, respectively. With the July print likely to be revised even higher in the months to come, the year-on-year core numbers are showing no signs of abating, and are significantly higher than the 4-5 % historical average that the RBI seems to be implicitly targeting.
 
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Ominously, even the monthly momentum of core inflation ticked back up (0.4 % m/m, sa) after being essentially flat for two of the last three months. Furthermore, this was not driven by one or two sub-groups. Instead, the price increase was across the board with 10 of the 13 main sub-groups of the manufacturing index posting price increases -- and many of them sharp increases at that. It was only because cotton textile prices declined very sharply on a sequential basis (-3. 4 % m/m) – reflecting the correction in raw cotton prices globally -- that core inflation did not accelerate even more sharply on a sequential basis and did not fully capture the breadth of the increases.
 
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As we have been repeatedly indicating (see, “India: IP surges, trade flows remain strong and tax collections buoyant allaying fears of a sharp slowdown,” August 12, MorganMarkets ) while though the economy may undoubtedly be slowing, the extent of the slowdown is likely being overstated, and is still not enough to significantly diminish pricing power. Today’s core inflation print is likely more evidence of this.
 
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RBI likely to keep going
 
The next policy review is still a month away and markets will keep a keen eye on the GDP, IP, PMI and inflation prints that are due before the next policy review. But data releases over the last week in India seem to have confirmed that the more things have changed globally, the more they have remained the same in India: activity continues to be stronger than commonly presumed, headline and core inflation remain elevated and significantly above the comfort zone of policymakers, producers still retain pricing power and household inflationary expectations remain elevated. Barring a sharp global shock in the coming weeks, all this should translate into another rate hike a month from now.
 
 
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