RBI hawkishness works as CPI Inflation tapers to 6.71% for July

This is the third successive month inflation tapered and now the headline inflation is down 108 bps from the April peak. Economists expect the CPI inflation to stay around these levels for next two months due to lower than expected Kharif output. Despite the fall in headline inflation, July marks the seventh consecutive month that inflation has been above the outer RBI tolerance level of 6%.

July 2022 also marks the 34th successive month that retail inflation stayed above the RBI median target of 4%. Remember, 6% is the outer tolerance limit while the target median inflation in India is 4% as per RBI estimates. Food inflation tapered sharply by 100 bps from 7.75% to 6.75%, but core inflation once again crossed the 6% mark in July 2022. The RBI tightening measures, which began in May 2022, appears to be delivering the results.

Data Source: MOSPI

May 2022 showed the first signs of food inflation tapering from 8.38% to 7.97%. In June 2022, food inflation fell to 7.75% and by another 100 bps to 6.75% in July 2022. Effectively, food inflation is down 163 bps since May. While food inflation has fallen, one concern is that the Kharif acreage has been lower this year compared to previous year and that could impact sentiments and the agricultural supply chain.

However, we must put inflation in context. In the six months prior to May 2022, food inflation spiked by 670 bps so the spike is still only partially undone. In July  2022, fuel inflation accelerated to 11.76% but transport inflation tapered to 5.5%, falling nearly 400 bps in last 2 months.

Rural inflation continues to be higher than urban inflation

There has been a mixed trend on the inflation front in rural India. On a MOM basis, the rural food inflation tapered from 7.61% to 6.80%. However, the overall rural inflation has fallen much less from 7.09% to 6.80%, so non-food items are putting pressure on rural inflation. Rural India is facing the impact of non-food inflation much more than food inflation. Supply chain constraints are still exerting pressure on inflation in rural areas and that has led to rural non-food inflation falling much less than food inflation.

In terms of the rural food basket, inflation in oils & fats fell sharply from 9.30% to 7.15% while spices inflation spiked from 11.12% to 13.02%.
Vegetable inflation tapered from 15.69% to 10.34%, but still high in absolute terms. Rural inflation in high protein foods like eggs and milk have tapered with egg inflation dipping into the negative. In the rural basket, fuel bounced from 9.25% to 10.52%, clothing & Footwear from 9.60% to 9.98% and personal care effects at 5.80%. In short, rural food inflation tapered, but other items ended higher.

Core inflation is back above 6% in July 2022

In June 2022, core inflation had fallen marginally below 6% mark but in July 2022, it has bounced back above 6% as supply chain constraints are hitting costs. However, core inflation at 6.01% is sharply lower than 6.97% in April 2022. While core inflation refers to the basket excluding food and fuel, the price of petrol and diesel has a strong impact on core inflation due to strong externalities of fuel.

The structural nature of core inflation makes it tougher to manage and regulate. The last Economic Survey ahead of the Union Budget 2022 clearly underlined the need to focus on core inflation more than headline inflation. Core inflation around 4% should be ideal, but that looks some time away and it remains to be seen if the RBI hawkishness can help.

Data Source: MOSPI / CEIC

The challenge is that controlling core inflation is a trade-off between government revenues and the larger goal of inflation control. That is the dilemma that the government faces today. The battle against inflation is having a fiscal cost in the form of duty cuts and that is impacting government revenues.

Now for the food basket story for Inflation July 2022

Here are some of the major highlights of the food basket story in July 2022

·         Meat and fish inflation tapered to 3.00% in July 2022 compared to 8.61% in June 2022 and 8.23% in May 2022. Egg Inflation was still negative at -3.84% in July 2022 compared to -5.48% in June 2022 and -4.64% in May 2022.

·         Fruits inflation bounced sharply to 6.41% in July 2022 compared to 3.10% in June 2022 and 2.33% in May 2022. Vegetable inflation tapered to 10.90% in July 2022 compared to 17.37% in June 2022 and 18.26% in May 2022. Vegetable inflation is tapering, but still high in absolute terms, especially considering its 13.2% weightage in the food basket.

·         Pulses inflation stood at 0.18% in July 2022 compared to -1.02% in June 2022 and -0.42% in May 2022. Cereals inflation was bounced to 6.90% in July 2022 compared to 5.33% in June 2022 and flat inflation in May 2022. Sugar inflation was higher at 4.80% compared to 4.17% in June 2022 and 4.27% in May 2022.

While the high protein food items are tapering, vegetables inflation is still in double digits. There has been a spike in cereals inflation due to lower acreage in this Kharif season.

Inflation on track, now focus on preserving growth

The RBI embarked on its hawkish journey in the special MPC meet in May 2022. In the MPC meetings of May, June and August 2022, the RBI hiked the rates by 140 bps in 3 tranches. In addition, the reverse repo rate was replaced with the SDF rate, which was tantamount to another hike of 40 bps. Also, to suck out liquidity from the system, the RBI hiked the CRR by 50 basis points. All these have had a cumulative impact on headline inflation as it tapered by 108 bps from 7.79% in April 2022 to 6.71% in July 2022.

Does that change the narrative of the RBI going ahead? The RBI would look for more ratification from the US Fed and the WPI inflation number. If the Fed turns less hawkish and the wholesale inflation falls below 15%, the RBI has reason to reduce its focus on inflation and look at growth levers. Even the IMF has clearly stated that India would be the fastest growing large economy in FY23 and FY24. India would not want to cede that advantage by being overtly hawkish!