Rising inflation, falling IIP worst combination; will it force RBI to change stance?

"It is a worry on both front, CPI after staying at 4 percent level for 2 months has risen to over 5 percent in the month of February. The rise in inflation is on account of elevated food, vegetable prices, core inflation at 5.88 percent is a concern. The rising crude price and its impact on retail fuel prices are a risk to inflation going forward," said Nish Bhatt, Founder & CEO, Millwood Kane International.

Retail inflation prints may remain high for the next few months due to high commodity prices.

Rahul Bajoria, Chief India Economist at Barclays believes increasing input costs, higher commodity prices and seasonal upside in food price during the summer will keep inflation elevated for the next few months, especially as pricing power returns.

"Supply-driven price pressures will remain high, as cooking fuels and gasoline are likely to stay elevated, in sync with surging crude oil prices. The continued fall—though slowing—in vegetable prices and moderation in gold and silver prices could partly mitigate price increases in other commodities. As goods inflation rises faster than services, it should push WPI over CPI inflation by a considerable margin," said Bajoria.

Bajoria sees inflation averaging 5.2 percent in the first half of FY22 and then moderating to 4.5 percent.

Rising inflation and faltering growth may put the Reserve Bank of India (RBI) in a spot in its April policy meet.

"After growth in December, the industrial production contracted in January mainly due to weakness in manufacturing and mining component, this despite progressive unlocking by government in most pockets of the country. This rising inflation and falling industrial production scenario are likely to have a bearing on the MPC meeting next month," Bhatt of Millwood Kane International said.

Brokerage firm Emkay Global said despite a resumed uptrend in CPI inflation, the RBI’s Q4FY21 estimate of 5.2 percent could see a 25-30bps cut.

"If the food inflation normalises in the next year to sub-3 percent (from 8 percent+ in FY21E), the headline inflation could average 4.5 percent in FY22E versus nearly 6.2 percent in FY21E," Emkay said.

The brokerage, however, added that the risk of increasing input costs, higher commodity prices and seasonal upside in food prices and better pricing power remain key risks to inflation.

"We see core inflation outdoing headline inflation through most part of FY22, averaging 5.2 percent, same as FY21. While this could worry the policymakers, the policy stance will likely remain accommodative on both rates and liquidity front in CY21," Emkay said.

On IIP, Emkay said it is a temporary blip as activity indicators show improvement in Q4FY21.

The sharp reversal in the CPI inflation reflects the potential inflationary pressures in the economy. Suman Chowdhury, Chief Analytical Officer, Acuité Ratings & Research, is of the view that the CPI print reinforces concerns of a further increase in core inflation amid the ongoing economic revival.

"RBI is expected to keep a close eye on the inflation trajectory despite its strong focus on economic revival and suitably calibrate its monetary policy," Chowdhury said.

"The IIP data for Jan 2021 indicates that the ongoing industrial revival is still tenuous. What is interesting is the continuing growth in power output both on a year-on-year (YoY) and month-on-month (MoM) basis at this stage. Some of the expectations on meaningful positive GDP growth in Q4FY21 may get weakened if the industrial activity does not pick up further in February and March 2021," Chowdhury added.

In its February policy meet, RBI revised CPI projection to 5-5.2 percent for the first half of FY22 from 4.6-5.2 percent. It also revised the CPI projection for Q4FY21 to 5.2 percent from 5.8 percent.

The central bank also reiterated that the accommodative stance will continue as long as required as the need of the hour is to continue supporting growth. RBI MPC, most likely, will maintain the status quo in its April meet.

"The downward sloping headline and core CPI profile, even from somewhat elevated levels, rule out an early exit from easy monetary conditions, in our view. Already, the RBI’s gentle nudge for liquidity normalisation has resulted in higher market yields, which has raised the cost of funding. We do not sense urgency on RBI’s part to push up borrowing costs, and they will likely wait for more signs of sustained growth before signalling any change in rates policy," Bajoria of Barclays said.

Nikhil Gupta, Chief Economist at Motilal Oswal Financial Services, agrees that the pick-up in inflation and fall in IIP is the worst possible combination.

"We hope IIP would come back into growth territory from Feb-21, though CPI may pick up further to about 5.4 percent in March 2021. Accordingly, we expect MPC to maintain status quo in April's policy," he said.

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