Deutsche Bank sees India's CPI inflation dipping below 3% in July 2024

CPI inflation cooled to 6.83 percent in August, as per data released on September 12.

India's headline retail inflation rate could fall to as low as 2.9 percent by the middle of 2024 provided there is no food price shock similar to this year, with an "exceptionally favourable base effect" playing a starring role.

"As Consumer Price Index (CPI) inflation is likely to average 6.4-6.5 percent in July-September 2023, it can potentially fall below 4 percent average in July-September 2024 due to the exceptionally favourable base effect, absent similar food price shocks next year," Kaushik Das, Deutsche Bank's chief economist for India and South Asia, said on September 12.

"As of now, we are forecasting July 2024 CPI inflation at 2.9 percent, August 2024 CPI inflation at 3.3 percent, and January-March 2025 CPI average at 4.5 percent," Das added.

The Reserve Bank of India's (RBI) official forecast pegs average CPI inflation at 6.2 percent for July-September, 5.7 percent for October-December, and 5.2 percent in each of the first two quarters of 2024. Inflation was last below the central bank's medium-term target of 4 percent in September 2019, when it had come in at 3.99 percent.

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The Deutsche Bank economist's comments came immediately after data released by the statistics ministry showed CPI inflation fell to 6.83 percent in August, slightly lower than the consensus estimate of 7.0 percent, as the fall in prices of key vegetables such as tomatoes in the second half of August dragged down the headline inflation figure from July's 15-month high of 7.44 percent. And Das, like many other economists, expects the "bigger disinflation" to occur in September and thinks inflation could fall to as low as 5 percent going by current trends.

CPI inflation data for September will be released on October 12, less than a week after the RBI's Monetary Policy Committee (MPC) announces its next interest rate decision on October 6.

"While markets have priced out expectations of rate cuts at this stage, we think the situation may change in the next few months once CPI inflation eases materially due to vegetables price disinflation," Das, who expects the MPC to cut the repo rate by 100 basis points starting in April, said.

One basis point is one-hundredth of a percentage point.

Difficulties in forecasting

According to Das, who saw inflation easing to 7 percent in August, a spike in vegetable prices tends to result in higher-than-expected inflation numbers. The opposite seems to hold true when these prices correct sharply.

"Having seen this dynamic play out in past cycles of volatility in vegetable prices, we are in a sense not surprised by the downside surprise to the August CPI print compared to consensus estimate. We anticipate that even in September, actual headline CPI will surprise to the downside," he noted.

Also Read: What the economist who got July CPI inflation (almost) right thinks will happen next

In August, food inflation fell to 9.94 percent from 11.51 percent in July. Within food, the price fall was led by vegetables, whose index was down 5.9 percent from July. This followed a dramatic July, when the vegetable index surged 38 percent month-on-month (MoM), resulting in a 6.7 percent sequential rise in the Consumer Food Price Index and a 2.9 percent increase in the overall CPI.

"Over June and July, food prices have increased by nearly 8 percent MoM, while in normal circumstances they should have increased by about 2 percent MoM. So there has been a 6 percent MoM excess spike in food prices, particularly led by vegetables such as tomatoes," Das said.

"We assume that food prices will correct only 3 percent MoM out of this 6 percent MoM excess spike, that is only 50 percent mean reversion, factoring in risk of price rise in some of the food items apart from vegetables," he added.

Despite the huge volatility in vegetable prices, Das has not made any change to his inflation forecast of 5.3 percent and 5.2 percent for October-December and January-March 2024, respectively, choosing to wait until the data for September is released next month.