Thursday, January 16, 2014

India Inflation Slows

India’s wholesale price index (WPI) inflation is due for release Wednesday and after the notable pullback in the consumer price index (CPI) earlier this week, markets are primed for a downside surprise in this account. December CPI inflation slowed to 9.9% on-year,
down from revised 11.6% in November and back to the underlying trend. The downward correction was more signifi¬cant in the urban areas at 9.1%: the weakest pace in more than 20 months, while the rural consumers’ index was slightly weaker.

On the WPI, our estimate is for 7.1% on-year, from 7.5% the month before. Easing vegetable prices should provide a reprieve to the food price index, after the component rose 19% between August to November, doubling from 9.9% in the 2012/1313 fiscal year. Trends from the agriculture ministry data show that prices of common vegetables, es¬pecially onions, fell by over 50% on-month in December, following the arrival of the winter crop and stepped up supplies. The central bank has also raised concerns that price pressures run the risk of becoming general¬ised. Hence, attention also needs to be paid to the trends in the non-food com¬ponents – mainly manufacturing, fuel and core (non-food manufacturing used as a proxy) indices, which have ticked up in the past couple of months.

Rupee stability has also been positive for the inflation outlook. On a related note, the Reserve Bank of India (RBI) lifted the restrictions on rebooking and cancellation of foreign-exchange forward contracts earlier this week. With the currency displaying relative resilience to the US quantitative easing tapering worries and measures to buoy the capital account to address the current account financing worries, the central bank has leeway to allow more flexibility in hedging rules. As these were imposed to restrict suspected speculative bets against the currency, the relaxation reflects policymakers’ confidence that the currency markets can handle intermittent bouts of volatility.

If the actual WPI inflation is close to our estimate or registers a downside surprise, the odds for a "no-action" decision at the RBI’s January policy review are high. However, it would be premature to assume that the central bank will switch gears to an accommodative policy bias amid elevated inflationary expectations and strength in rural wages. These factors along with gradual adjustments in fuel/utilities/ coal prices are likely to keep WPI inflation from easing significantly beyond the 6.5%-mark.