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