Food inflation unlikely to fall despite favourable monsoon

India Ratings & Research (Ind-Ra) believes despite the favourable impact of monsoon, it is quite unlikely that overall inflation will decline sharply any time soon. Headline inflation, on yoy basis, increased to 6.5 percent in September 2013 from 6.1 percent a month ago led by inflation in primary food products (18.4 percent) and fuel and power (10.1 percent). Even the consumer price index based inflation for September 2013 escalated to 9.84 percent as compared with 9.54 percent in August 2013.

Wholesale Inflation Rises: Wholesale inflation in September 2013 increased by 0.36pp over August 2013. Fruits and vegetables, and crude petroleum contributed 71.2 percent and 21.4 percent, respectively, to the increase in wholesale inflation in September 2013. Fruits and vegetables inflation increased to 49.1 percent in September 2013 from 42.4 percent in August 2013 and crude petroleum inflation increased to 6.1 percent in September 2013 from a deflation of 2.5 percent in August 2013. No Change in RBI Policy Stance: The reversal in inflation trajectory has reduced the Reserve Bank of India’s (RBI) elbow room to ease policy rates. Currently, marginal standing facility (MSF) rate is the operational overnight lending rate for the RBI; Ind-Ra expects easing of MSF rate and hardening of repo rate in second quarter review of the Monetary Policy on 29 October 2013. Over the next few quarters, the agency expects the spread between MSF and repo rate to revert to the normal 100bp. On the liquidity front, however, some liquidity infusion measures to correct the inverted yield curve are highly likely. Also, the introduction of innovative financial instruments over the next two quarters cannot be ruled out. Spurt in Food Prices: Food inflation, after falling to single digit in March 2013, has crept to double digits since June 2013. The spurt in vegetable prices since June 2013 has been one of the key drivers of food inflation lately. Due to adverse supply conditions, onion witnessed 323 percent inflation in September 2013. Cereals inflation is gradually declining; new rice crop will have an impact on rice inflation (18.8 percent in September 2013). Unlike a decade ago, the importance of cyclical factors in driving the food inflation has waned and the key factors driving food inflation are now structural in nature - declining agricultural productivity, bottlenecks in agricultural supply chain, etc. Winter to Help: Although vegetable prices have increased due to adverse weather conditions and supply shocks over the past few months, the onset of winter is likely to provide some breather. Typically, the supply of fresh vegetables and fruits goes up during winters. Moreover, wastage of fruits/vegetables also drops as the shelf life of these items, even in the absence of proper refrigeration, increases due favourable weather conditions. Suppressed Inflation: Notwithstanding some respite in food inflation in winter, suppressed inflation will continue to pose a major risk to inflationary expectation. Under-recoveries of oil companies have widened in the recent months due to the weakened rupee. However, it has yet not been fully passed on to the domestic consumers. Moreover, as companies begin to pass through rising import costs on account of the weakened rupee/rising input cost, inflation will rise.
 
Marginal Increase in Manufacturing Inflation: The manufacturing sector has been adversely impacted due to a sustained weakness in both domestic and global demand. Index of industrial production over April-August 2013 grew by just 0.1 percent yoy. This has reduced the pricing power of companies to offset rising input/wage costs. Although both-manufacturing as well as core (non-food manufacturing) inflation increased marginally in September 2013 from August 2013, they continue to be low and well within RBI’s target range of 5 percent or less. In September 2013, manufacturing and core inflation was 2.0 percent and 2.1 percent, respectively. Inflation in Fuel and Power to Drop Further: Inflation related to fuel and power eased to 10.1 percent in September 2013 from 11.3 percent in August 2013 in yoy terms, but rose by 2.6 percent in mom terms in September 2013. The surge in mineral oil inflation was mainly due to the rise in diesel prices by 20.1 percent, bitumen by 22.1 percent, light diesel oil by 15 percent and petrol by 9.6 percent. As diesel prices were raised by INR5/litre in mid-September 2012, diesel inflation is likely to come down October onwards due to the high base.

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