Base effect led fall does not mean the start of inflation easing cycle

The base-effect-driven fall in India’s headline inflation rate in October is not the beginning of the easing of the inflation cycle, Kunal Kumar Kundu, India economist at Societe Generale, has said.

The consumer price index (CPI)-based inflation rate fell to a three-month low of 6.77 percent in October from 7.41 percent in the previous month due to a favourable base effect.

Inflation is the change in the consumer price index, ie the base, from a year ago. A lower year-ago index number can push up the inflation rate, while a high base can bring the inflation rate down.

Inflation, however, has remained above the Reserve Bank of India's upper tolerance ceiling of 6 percent for 10 months, indicating a failure to meet the inflation target. The central bank recently sent a response to the government explaining the reason for the failure to contain rising prices.

“Given that the sharp drop in year-on-year print is accompanied by a strong uptick in month-on-month print, we do not see indication of any major easing of price pressure,” Kundu said in a note.

“We believe that over the next few months it will again be the base effect that could push inflation once again to beyond 7 percent starting from December once the favourable base effect turns decisively adverse.”

Also read: MC Explains | What's driving inflation down?

The RBI’s rate-setting panel has raised the repo rate by 190 basis points in the last six-and-a-half months to 5.9 percent. But economists expect the quantum of rate hikes to ease going ahead. Jayanth Varma, member of the rate-setting panel has called for the committee to "pause rather than focus on further tightening".

Also read: Major global economies seem to have left worst of inflation behind

The central bank is near the end of its rate hike cycle, Kundu said.

He expects another 60 basis points of cumulative rate hikes over the next two meetings, taking the terminal policy rate to 6.5 percent during January-March 2023.

It “should eventually translate into the real policy rate turning positive after a rather prolonged period of being in the negative”, he added.

While core inflation continues to be a problem, cost pressures seem to be waning, the economist said, citing the drop in wholesale price inflation in October.

Also read: October inflation down at 6.8%: It's stats at play, MPC can't lower the guard so soon

With pent-up and festival demand behind us, retail prices could eventually start easing from next year.

With no major economy-wide wage pressure and weak labour market recovery, elevated inflation and a higher level of inventories will eventually force retailers to start offering discounts resulting in the eventual disinflationary trend, Kundu added.