Unfavourable turn in CPI base to pour cold water over food price fall in December 2021

Prices of food items declined in December 2021. But thanks to the Consumer Price Index (CPI) base turning unfavourable, even a fall in prices of key items such as vegetables is unlikely to have prevented a rise in headline retail inflation.

According to data from the Department of Consumer Affairs, the retail price of onion, potato, and tomato fell 11.7 percent, 9.5 percent and 8.1 percent, respectively, in December 2021 from the previous month.

Sequential price movements were largely downward for pulses and edible oils too. Four of the five pulses on which the consumer affairs department collates data saw their prices fall by 0.7-1.9 percent in December 2021 from November 2021. Only the price of masoor dal ticked up by a marginal 0.1 percent.

The story was similar for edible oils, with four of the six on which data is available witnessing a month-on-month price fall of 0.4-1.7 percent. The other two, groundnut and mustard oil, saw a marginal increase in their price.

Cereal prices were largely unchanged, while sugar was 1.2 percent cheaper than in November.

Put together, the impact of the above should result in a fall in food price momentum after November 2021 saw the Consumer Food Price Index rise 1.3 percent from October 2021 and helped push up CPI inflation to 4.91 percent.

However, a turn in the base effect will likely push CPI inflation significantly higher in December 2021, data for which will be released on January 12.

The general index of the CPI fell 1.0 percent month-on-month in December 2020 to 157.3. Given that this will form the base on which CPI inflation for December 2021 will be calculated, inflation should trend higher. In fact, if the general index was to remain unchanged in December 2021 from the previous month's 166.7, headline retail inflation would jump to a six-month high of 6.0 percent.

The Reserve Bank of India (RBI) has forecast average CPI inflation for October-December 2021 at 5.1 percent. This average would be met even if one assumes 6.0 percent for December 2021. As such, a significant jump in inflation would not play havoc with the current course of monetary policy.

Of course, there is nothing to say the general index of the CPI will remain unchanged in December 2021 considering it rose in all bar one of the previous months of 2021, with the index posting sequential gains at a monthly average of 0.5 percent in January-November 2021.

While the fall in price of food items could help keep the month-on-month rise in the general index in check, other components of the CPI basket are unlikely to offer any such assistance. Higher telecom tariffs and the likelihood of elevated services inflation should raise core CPI inflation further from 6.1 percent in November 2021. Moreover, with petrol and diesel prices little changed, except in Delhi, fuel price momentum may remain strong.

Inflationary pressures may be strengthened going forward on account of the restrictions being imposed to combat the surge in COVID-19 cases.

"We are concerned that the third wave, similar to previous waves, could lead to supply-side inflationary pressures in January, which are likely to remain sticky. Thus, we raise our Q1 2022 inflation forecast by 0.2 percentage points to 6.4 percent, and 2022 to 5.7 percent (from 5.6 percent)," Nomura economists said in a note.

These forecasts are well above those of the RBI. The central bank expects CPI inflation to average 5.7 percent in January-March 2022 before easing to 5.0 percent in the next two quarters.

Unsurprisingly, Nomura expects the RBI's monetary policy committee to kick-start the rate hike cycle in April 2022 and increase the policy repo rate by a total of 100 basis points in 2022.