Home/Blogs/Will non-food inflation continue to spook retail inflation?

Will non-food inflation continue to spook retail inflation?

commoditycommodity accountcommodity marketcommodity trading
04 Feb 20206 mins readBy MOFSL

The inflation index, especially the retail inflation as represented by the CPI inflation index, lies at the heart of the RBI monetary policy. To understand CPI inflation it is essential to understand its two components; food inflation and non-food inflation. Over the last 3 meetings of the Monetary Policy Committee (MPC), the 6 members of the MPC have consistently focused on the rising threat of non-food inflation. Between 2014 and 2016, the real worry was on the food inflation front. Two successive years of drought in 2014 and 2015 had resulted in food production falling and weak distribution infrastructure only exacerbated the situation. During that period it was food inflation that actually drove the overall inflation.
 
Things changed drastically after a normal monsoon in the year 2016. In fact, the Kharif output was nearly 9% higher for the year 2016 and that served to keep food inflation under check. The chart below tracks how overall CPI inflation and food inflation panned out since the monsoon last year
 

 
Food inflation has been contributing less to overall CPI inflation
One trend is very clear from the above chart that food inflation has been forming a lower proportion of overall CPI inflation. In fact post August 2016, when the Food inflation chart cut below the CPI inflation chart, it is non-food inflation that is contributing more to the overall inflation index. However, analysts will have to be a little careful in arriving at a conclusion of benign retail inflation for two reasons. Firstly, the low food inflation was largely driven by pulses and vegetables; both of which showed negative inflation. While the negative inflation in pulses was due to the base effect, the negative inflation in vegetables was more due to the fire sales conducted at mandis considering its perishable quality. That could be misleading. Secondly, the belief is still that the monsoon for the year 2017 could be slightly below normal due to the impact of El Nino. Normally, El Nino tends to result in the monsoons underperforming. Hence these two factors need to be considered before drawing conclusions on the benign nature of food inflation. As the base effect stabilizes food inflation could gradually increase and play a more important part in overall retail inflation.
 
But non-food inflation could actually hold the key
The above trend clearly indicates that the major traction on CPI inflation in the last few months has come from non-food inflation. What has driven non-food inflation? Firstly, there is the price of crude oil. Crude oil not only becomes a part of fuel inflation but also has downstream ramifications on other sectors and tends to inflate costs across sectors. With the OPEC supply cuts in place, crude oil was showing an upward trend. With crude oil prices now falling below the $50 mark, the only worry is that the government may once again use lower crude prices to increase the excise on diesel and petrol, which will again tend to be inflationary.
 
The second aspect is that of services inflation. Of course services like transportation are largely linked to fuel costs and hence higher oil leads to higher services inflation. There is also another tax angle to services. Last year, the rate of service tax was increased from 14% to 15% through the imposition of the Swacch Bharat Cess and the Kisan Kalyan Cess. July 2017 will usher in the Goods & Services Tax (GST) regime in India. One of the outcomes of GST will be to increase the rate of service tax from 15% to 18% to put it at par with the overall revenue neutral rate. That could contribute to inflation in key services like transportation, telecom, education etc.
 
What will eventually drive retail inflation in 2017?
There is the risk of upside slippage in food inflation if the El Nino happens and monsoons are below normal. Food inflation could also get exacerbated as the impact of the base effect starts to wane. But the real worry in this year could be the impact of non-food inflation. Firstly, the government could use lower crude prices to hike the excise on petrol and diesel. That will have larger ramifications for downstream inflation. Secondly, GST could be the big X-factor. With services very likely to get costlier, we expect strong downstream ramifications on prices. The MPC is right in saying that the non-food inflation could be the key to watch out for. That could be the real risk for the Inflation Index in 2017!

Related Articles: Can the commodity markets provide cues for equity trading | Beginners Guide to Agri Commodity Trading | 5 Successful Commodity Trading Strategies | Role of Commodity Markets In India 

Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
Open Demat Account
I wish to talk in South Indian language
By proceeding you’re agree to our T&C