The retail inflation in India, as measured by CPI inflation, has shown a sharp downward trend in the last 9 months since July 2016. Inflation topped out after the first signals of a good monsoon started coming in last year. While the RBI may still not be convinced about the need to cut interest rates in its June 2017 Monetary Policy, sustaining low inflation is essential for the RBI to continue to maintain a hawkish to neutral view on rates. Low levels of inflation are also essential to ensure that real returns in equity and debt are attractive enough for investors. The chart below captures the CPI inflation trend over the last 1 year..
Data Source: MOSPI
Ten Broad factors that could impact retail inflation going ahead
1. A key driver for inflation is the monsoons. A good monsoon normally results in a better Kharif crop. After 2 years of drought in 2014 and 2015, India had normal rainfall in 2016. This resulted in the Kharif production higher by 9%. A higher Kharif production is dependent on the quantum of the monsoons. In fact, the good monsoon was largely instrumental in the sharp fall in CPI inflation since July 2016.
2. Apart from the quantum of the monsoons, the spread of monsoon and the timely onset of monsoon also have an impact on CPI inflation. If the onset of monsoon gets delayed, then the cropping season may be missed out in many Kharif growing regions. That is why you find that a delayed monsoon normally gives a push to food inflation, which constitutes nearly half of the overall CPI inflation.
3. The base effect is an important factor driving the CPI inflation. Take the case of pulses. Through most of 2015 and 2016, the prices of pulses had touched all-time highs. When you compare to lower prices of pulses today, you end up having negative inflation. That is one of the reasons why pulses have had negative inflation for over 8 months as the base effect has a strong impact on the retail inflation number.
4. Perishables are another important determinant of CPI inflation. Perishables like vegetables and fruits tend to have very limited shelf life. If the product cannot be sold within the stipulated time, they have to be disposed off through fire-sales. We have seen fire sales of vegetables in many Mandis across India and that largely explains why vegetables have also shown negative inflation in the last 6 months.
5. The direct and indirect impact of
plays an important role in the direction of CPI inflation. Fuel has a weight of 8% in the overall CPI inflation and hence shifts in fuel costs tend to impact CPI inflation. But the bigger impact is indirect. Fuel becomes an important input for transportation and that is an important constituent of the overall cost structure in the economy. When you consider the downstream impact of oil, the actual magnitude of oil’s impact on CPI inflation is quite heavy.
6. Supply bottlenecks are a very important component of CPI inflation. Supply bottlenecks refer to the capacity of the economy to bring food from farm to fork. Traditionally, India has suffered from problems like poor road infrastructure, poor transport facilities, outdated warehousing and cold storage facilities etc. All these contribute to the retail inflation which is why the government is seriously working towards de-bottle necking them.
7. The first six factors were all supply driven factors. There is also a demand pull factor with respect to CPI inflation. When the government puts more money in the hands of people through measures like OROP and 7CPC, which can be inflationary. More income leads to more demand among sections of the society that have a high propensity to consume. Similarly, the NREGA and other rural employment guarantee programs have also contributed to CPI inflation.
8. A key determinant of CPI inflation will be the direction in which oil dividends flow. Since November 2014, oil dividends have flowed from oil producers to oil consumers and from oil exporters to oil importers. This has been anti-inflationary for countries like India. If this direction changes then that can be inflationary from the CPI perspective.
9. Imported inflation may be hard to fathom but it is an outcome of a weak rupee. Since India runs a trade deficit of approximately $13 billion per month, a weak rupee can result in imported inflation. On the other hand, when the INR strengthens versus the dollar as has been the case in the last 3 months, it tends to be anti-inflationary. For now it looks like the INR will maintain its strength vis-a-vis the dollar.
10. Government taxes have a very important role to play in the level of inflation. When the landed cost of oil was sharply falling due to weak crude prices, the government increased excise duty on petrol and diesel consistently to prop up its revenues. As a result weak global oil was not as anti-inflationary as it should have been.
To conclude, the retail inflation is likely to continue to be driven by food prices and fuel prices. Food prices will continue to depend on the vagaries of monsoon just as fuel will continue to depend on the vagaries of global equations. For now, the bias seems to be towards lower retail inflation in the months to come.