CPI inflation tumbling to a low of 3 per cent year-on-year in April 2017, has once again raised hopes of a rate cut by the RBI, after a long hiatus.
The yield on the 10-year G-Sec has fallen by 30 basis points since May 12, when the latest CPI inflation numbers were put out. But is the downward trend in inflation sustainable? Will the RBI that reversed its stance from accommodative to neutral in the February policy, change its view once again?
What moved inflation?
Over the past year, the steady fall in CPI inflation has been led by food that has a 45 per cent weightage in the CPI basket. The fall in CPI inflation from 5.5 per cent in April 2016 to 3 per cent April 2017, has been thanks to the sharp drop in food inflation from 6.3 per cent to 1.2 per cent during this period.
Interestingly, within food, cereals that have the highest weightage, witnessed a continuous upward pressure on prices. From 2.5 per cent in April 2016, inflation in this component has moved up to 5.1 per cent in April 2017. Milk that has the second-highest weightage, has also moved up over the past year. Then what has led to the sharp fall in food inflation? Vegetables that have the third-highest weightage within food has fallen steeply over the past year. After sporting a double-digit inflation between May and July 2016, the pricing pressure in vegetables eased substantially through the year.
In fact, even before the sharp 10-15 per cent fall between November 2016 and January 2017, possibly on account of demonetisation, vegetable inflation had moved into the negative territory, in the preceding two months. In April 2017, vegetable inflation was a negative 8.5 per cent.
Pulse prices too have seen a significant drop in recent months, softening food inflation.
While a bumper crop triggered a fall in vegetable and pulse prices over the past year, the trend in the coming year hinges on monsoons, in particular due to the rising risk of El Nino.
El Nino is known to affect kharif output as 55-60 per cent of the country’s sown area is still rain-fed. Aside from oilseeds such as soyabean, groundnut and castor seeds, pulses too may take a hit.
Also, due to the price collapse in pulses and oilseeds last year, production targets for FY18 may well fall short, according to market players. This could strip food inflation off the gains from lower pulse and oilseed prices in the coming year.
Hence, the trend in food inflation that triggered the sharp fall in CPI inflation over the past year, is unclear as of now.
Upside risks persist
Food aside, the core CPI inflation (excluding food and fuel), did trend lower to 4.5 per cent in April 2017 from the previous month. But while this may set the stage for lower inflation in the first half of FY18, below the 4 per cent mark, upside risks persist in the second half of the fiscal. Monsoon uncertainty, an HRA increase under the Seventh Pay Commission, temporary impact of GST and base effect trickling in, are likely to push up inflation to 5-5.5 per cent in the second half of FY18. This is in line with the RBI’s assessment in its April policy. This is unlikely to change significantly.
Change in stance unlikely
The RBI is unlikely to change its stance solely on the account of the positive surprise on April inflation numbers. At best, rate hikes that were expected over the medium term are in for a long pause.
Much to the market’s disappointment, though, the RBI is most likely to keep rate cuts on hold too. The still excess liquidity scenario is a key hindrance for the RBI to do a volte face on its neutral policy stance.