Analysis | May CPI numbers offer some relief to MPC, but don’t uncork the bubbly yet

On a month-on-month basis, retail inflation has actually risen with the general index of the CPI up 0.5 percent from April.

On June 13, 2023, government data showed that India's headline retail inflation rate dropped to 4.25 percent in May from 4.70 percent in April, the lowest in 25 months. That's certainly good news for the central bank which has been fighting a hard battle to check the price rise that is snatching away the fruits of economic recovery from India's poor households.

Logically, the CPI numbers should give further relief to the Reserve Bank of India-led Monetary Policy Committee (MPC). This shows that the panel's decision to hold the rates and wait for the effect of the previous rate hikes to take effect was right. The MPC, which kept the repo rate unchanged at 6.5 percent, will now strive to align inflation around the 4 percent target, after bringing the number within the 2-6 percent target band.

Even then, it may be too early still for the MPC to think of a rate reversal. There are a few risk factors that the central bank  could still be worried about:

One, essentially, a major factor that has pulled down the May inflation number is the base effect. On a higher base last year, the increase will show lower this year although in absolute terms the rise is similar. However, in the approaching months, the base effect will likely fade out pushing the inflation back to the 5 percent levels.

Two, a normal monsoon is a key assumption for the central bank’s inflation forecast. While the IMD has predicted normal monsoon this year, Skymet has predicted a below-normal monsoon. A failure in monsoon could upset inflation projections.

“While normal monsoons are predicted, timeliness and regional distribution are critical for crop production, price signalling and for shaping inflation expectations,” said Crisil chief economist DK Joshi in a recent note, adding that any distortion in rains could bring a reversal of gains in categories experiencing low or easing inflation (vegetables and edible oils), or worse, keep inflation elevated in cereals, which are experiencing double-digit inflation.

Third, El Nino too could play spoilsport in the course of inflation. There is no certainty yet on how this will pan out. According to Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India, continued vigil on the evolving inflation outlook is warranted, especially as the monsoon outlook and the impact of El Nino remain uncertain. The MPC will be looking at this factor going ahead.

Four, on a month-on-month basis, retail inflation has actually risen with the general index of the CPI up 0.5 percent from April, while the Consumer Food Price Index was up 0.7 percent. Prices of certain items such as cereals and milk, which are commonly used in daily households, remain high.

“The worrying trends in May 2023 inflation are: a) cereals inflation although has reduced from its recent peak of 16.73 percent in February 2023 has remained in double digits in the last nine months, b) milk inflation remaining in excess of 6 percent in last 10 months, and c) core inflation remaining more than 5 percent in last 37 months,” said Sunil Sinha, Senior Director & Principal Economist, India Ratings and Research.

Five, global factors still pose a risk to local inflation projections. The RBI has said that this factor needs to be watched closely. In his policy statement on June 8, RBI Governor Shaktikanta Das had cautioned that volatility in global financial markets poses upside risks to inflation. The policy statement further highlighted that in several emerging market economies weak external demand, elevated debt levels and geoeconomic disintegration amidst tighter external financial conditions pose risks to growth prospects.

The MPC, hence, is likely to take a cautious approach while thinking about a rate cut. The panel, which once had to publicly admit failure to contain inflation within the targeted band, may not take chances again. It will perhaps wait for conclusive evidence of sustainable easing in inflation before taking a relook at the rate stance. If inflation sticks to the estimated glide path (5.1 percent for FY24), the window for a rate cut could open by January-March. That's still some time away.