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

As Moneycontrol reported, the base period for the latest inflation print - or October 2021 - the general index of the CPI had surged 1.4 percent on a month-on-month basis. The base effect caused inflation fall by about 0.8 percent this month.

Now, even with the base effect benefit, the inflation print doesn’t look comforting as it continues to stay above the 6 percent upper band.

The Reserve Bank's Monetary Policy Committee has faced the embarrassment for failing to meet the inflation target for three consecutive quarters, thus necessitating a formal written response to the government on the reasons of failure and the road ahead. Inflation averaged 6.3 percent in January-March, 7.3 percent in April-June, and 7 percent in July-September, causing the biggest embarrassment to the rate-setting panel since its start in 2016.

In this backdrop, at best, the fall in October inflation can be seen as a statistical phenomenon.

Further, there are factors and upside risks that prompts one to look at the inflation number with caution.

One, as CareEdge rating agency economists point out, retail prices have gained momentum in October compared to the last month in the food, housing and fuel and light segments.

Two, particularly, food inflation remains the villain in the inflation story, thanks to rising prices of cereals, vegetables and milk. Food inflation rose 7.01 percent last month. The rise is visible in vegetables (7.7 percent) and cereals (12.08 percent). It can be attributed to lower production and supply constraints caused by unseasonal rains.

Third, the core inflation, which excludes volatile components such as food and fuel, remains sticky at 6.2 percent. As the core inflation reflects the extent to which the inflation has become broad-based, the current level is worrisome, CareEdge said, adding the core CPI could remain sticky in the near term due to demand-driven pressures.

What Next for MPC?

Two biggest risk factors going ahead will be volatility in food prices and a course of the weak rupee. A weak rupee will put pressure on the current account deficit and fuel inflationary pressure. A weak currency discourages imports and the resultant price pressure in domestic market adds to the inflation.

It is very unlikely that the lower October inflation number will be seen as a big positive by the MPC members when it meets in December. It is too early for the MPC to think about lowering the guard on inflation after failing to meet its mandate. The panel has probably learned its lesson from inflation failure and would not want to risk slipping further.

The fact that the October number has come lower on account of a statistical play will be seen with caution by the members, prompting them continue with the tightening path.

It is fair to assume that in all likelihood, another 25-50-basis-point rate hike will happen in December, although the tone of the policy language may be a bit less hawkish. One basis point is one-hundredth of a percentage point.

The MPC is right now playing a catch-up game. It has hiked the policy rates by 190 basis points (bps) in the current rate hike cycle after waiting for too long to act. Inflation hasn’t shown any sign of abating to the desired level so far.

The RBI expects the softening to happen by the first quarter of the next fiscal year. Yet, that’s only an expectation at this stage. One needs to wait and watch how the actual scenario evolves. The RBI has gone wrong in the past on inflation calculations.