CPI: Inflation Surges Above Monetary Policy Committee’s Tolerance Level 

Retail inflation surged above the tolerance band of India's monetary policy committee, pushed up by a surge in food prices and an increase in telecom tariffs.

Consumer price inflation rose to 7.35 percent in December 2019, compared to 5.54 percent in November, according to data released by the Ministry of Statistics and Program Implementation on Monday. At current levels, inflation is at its highest since July 2014. Core inflation rose to 3.75 percent in December from 3.5 percent last month.

A Bloomberg poll of 37 economists had estimated inflation at 6.7 percent for December 2020.

Inflation Internals

The surge in inflation continues to be driven by higher prices across the food and beverages category.

Inflation in food and beverages segment rose to 12.16 percent compared to 8.6 percent in November 2019. Food and beverage inflation is at its highest level since December 2013. Vegetable prices surged to 60.5 percent in December over a year-ago, compared to a rise of 40 percent in November.

Onion prices, which rose over 300 percent over a year ago, remain the biggest pain point in the food category.

“The Inflation is driven by GOP — garlic, onion and potato,” said Soumya Kanti Ghosh, chief economist at State Bank of India. “If you sweep out the impact of these three commodities, the inflation rate falls to 4.48 percent. The impact of telecom tariffs is also 16 basis points, so if you leave out all these four items, inflation is actually at 4.32 percent,” he told BloombergQuint.

Aditi Nayar, principal economist at ICRA, said while vegetable prices led the spike in food inflation, prices of other food items, especially proteins, hardened appreciably as well.

Transport and communication inflation rose to 4.77 percent from 0.88 percent for the same duration, reflecting the telecom tariff hikes across service providers. Higher telecom costs were a key contributor to increased core inflation.

This isn't the end of it, Ghosh warned.

Siddhartha Sanyal, chief economist at Bandhan Bank, agreed. The inflation figure will be “significantly softer” in the early summer months, once the winter crops hit the market, he said. “Three or four months down the line, the scenario can be significantly different.”

According to Sanyal, the core inflation — the number which shows some kind of strength in demand — is still very weak. “Given the momentum of economic activity in the country is relatively poor, and consumer and business sentiment are not really that strong, it is unlikely that the inflation pressure will be generalised.”

Among other key components:

• Clothing and footwear inflation was at 1.5 percent in December compared to 1.3 percent in November.
• Housing inflation stood at 4.3 percent compared to 4.5 percent last month.
• Fuel and light inflation stood at 0.7 percent compared to a contraction of 1.9 percent last month.
• Household goods and services stood at 1.75 percent compared to 2.2 percent in November.
• Health inflation stood at 3.8 percent as against 5.5 percent in the preceding month.

Stagflation-Like Conditions

Inflation rising to above 6 percent will reduce the changes of another interest rate cut in February, even though RBI governor Shaktikanta Das had termed the pause in rate cuts as temporary. The MPC had voted 6-0 in favor of a pause in December, after 135 basis points in rate cuts over the course of 2019.

The higher inflation, coming at a time of very weak growth, leaves the MPC facing a dilemma. While lower growth may warrant a further cut in rates, inflation above the MPC's target may demand an end to the rate cutting cycle.

Economists are divided.

In a note on Monday, Bank of America Securities said that inflation will peak in December, allowing for another 25 basis point cut in rates in February. In contrast, Nomura Global Market Research expects a prolonged pause. The March quarter is likely to witness stagflationary conditions, Nomura cautioned. With the higher inflation trajectory, fiscal slippage in the coming budget and signs of stabilisation in high frequency data, the case for keeping policy rates on hold is now stronger, the brokerage house said in a report dated Jan.10.

India Ratings added that irrespective of the fiscal stance taken by the government,the RBI is unlikely to utilise the limited window for a rate cut in its February monetary policy review.