Inflation Bottoming Out?… Or… Is the Indian Economy Moving Towards Deflation?

-Report by Foram Ajani

A constant problem of galloping inflation has gripped the Indian economy over the years however, retail inflation based on Consumer Price Index (CPI), dropped to 2.99% in April following a 3.81% rise in March which was well below market expectations of 4%.

This was the lowest inflation rate since the series began in 2012, driven by a slowdown in food prices fall in the cost of pulses, cereals and perishable goods.

Inflation Rate in India averaged 7.13% from 2012 until 2017, reaching an all-time high of 12.17% in November of 2013 and a record low of 2.99% in April of 2017.

Causes of fall in CPI based Inflation:

  • Domestic price pressures have been well arrested given better food supply management.
  • Budgetary allocation for price stabilization fund in 2017-18.
  • Increased support prices.
  • Decreased import of potatoes, wheat, and palm oil and 20% duty on export of sugar.
  • Seasonality of fruits and vegetables has been updated (more months, i.e. longer duration- due to the wider spread the effective prices seem deflated)
  • Rupee appreciating was also one of the reasons for fall in inflation.

Wholesale Price Index (WPI) based Inflation: WPI fell to 3.853% in April from 5.509% in March

Causes of fall in WPI based Inflation:

  • Fall in mineral oil and fuel prices, there was a year on year (YOY) drop in mineral oil prices due to lower consumption of light diesel oil. The YOY fall in the consumption of diesel oil is driven by the shift from diesel oil to petrol due to high emissions of diesel.
  • Food priceinflation continued to fall. There was a dip in manufactured food products from 8.796% in March to 6.083% in April.
  • In Basic metals there was a drop in inflation from 6.27% in March to 5.562% in April.
  • WPI Food Index- The rate of inflation based on WPI Food Index consisting of ‘Food Articles’ from Primary Articles group and ‘Food Product’ from Manufactured Products group decreased from 5.50% in March, 2017 to 2.90% in April, 2017. WPI Food Index is used to capture the rate of inflation in food items.

Effects of Goods and Services Tax(GST) on Inflation:GST may have no significant impact on Inflation. The rise in inflation due to GST could be in the range of 10-70 basic points over the year.

Effects on Change in Crude Prices on Inflation: Assuming the impact of crude oil will remain marginal on inflation. There would not be a substantial change in inflation due to change in crude oil prices.

It has been reported that OPEC may extend production cuts till end of next year this would lead to oil prices remaining at the current level and thereby having a neutral to marginal impact on the inflation.

Effects Monsoon on Inflation:The India Meteorological Department has forecast the country will receive normal monsoon rainfall. The RBIs concern was a poor monsoon, which could result in a spike in food prices, which would force the central bank to raise interest rates.

Implementation of the Allowances recommended by the 7th CPC: In case an increase in House Rent Allowance as recommended by the 7th CPC is awarded, it will push up the baseline trajectory of CPI by an estimated 100-150 basis points over a period of 12-18 months.

Conclusion:In the coming months the inflation would remain steady and could tend upward due to the price rise in foodprices (seasonal rise in food prices). Demand conditions are also expected to improve, backed by a normal monsoon (estimated at 96% of the long-term average), a narrowing output gap and higher rural wages. Core inflation could edge up if domestic demand improves.

Interest rate cuts are not expected any time soon; since inflation is expected to remain stable at the current level and inflation is not likely to breaches RBI’s indicative trajectory of 4% level in the coming months.