Relapse of Inflationary pressure as demonetization fades
Inflationary pressures in February further accentuated at both wholesale and retail level, in line with our expectations. Fading off demonetization impact on inflation (bottoming out of vegetable inflation in Jan’17) is reflected in CPI and WPI inflation as it rose to 3.7% YoY and 6.6% respectively. We believe once the remonetisation gains momentum CPI could surge near to 5% levels (CPI ex vegetables). WPI inflation, for the 2nd consecutive month, surpasses retail inflation forebodes rising pipeline inflationary pressure for CPI. Also, the overall increase in CPI inflation was broad based as 91% of the CPI components increased in Feb’17 MoM (indicated by Diffusion Index). Based on rising inflationary pressure both in India as well as globally, RBI is likely to refrain from any further rate cuts. We continue to expect steepening of the yield curve and 10 year yields to harden in the range of 7.5-7.8%
CPI increases to 3.7% due to reversal in food inflation
CPI inflation rose to 3.7% in Feb’17 arresting the moderating inflationary trend witnessed since Jul’17. Food inflation contributed significantly to this change in CPI trajectory, as it increased to 2.0% YoY in Feb’17- led by softer decline in vegetables inflation (-8.3% YoY) as compared to previous month (-15.6%). CPI ex-vegetables remained sticky at 4.9% YoY. Core inflation moderated meagerly to 4.8% YoY, mainly due to high base. On monthly basis, all the components in core inflation increased however shaper increase was witnessed in personal care & effects (contributed by rise in gold prices) and rental inflation. Hike in petrol prices and market driven fuel items have resulted in higher transport and fuel & light inflation which increased to 5.4% YoY and 3.9% respectively. Rise in retail inflation was primarily driven by sharper increase in urban inflation which increased to 3.6% YoY from 2.9% in Jan’17. The gap between urban and rural inflation narrowed down to 12bps as urban inflation rose sharply to match the pace of rural inflation. While comparing the rural-urban CPI series, the reason behind sharper rise in urban inflation was due to sharper rise in vegetables inflation in urban areas.
WPI Inflation surged to 6.6% in Feb’17
Wholesale inflation increased sharply to 6.6% in Feb’17 as compared to 5.3% in Jan’17 mainly due to sharp rise in fuel inflation. WPI has regained post the initial reaction to demonetization in Dec’16 as clearly seen in reversal in vegetable prices. WPI, so far this fiscal (Apr-Jan’17) has increased by 582bps, highest buildup in prices in last 4 years. Latest reading portrays that input inflation has gained pace in last two months, indicating rise in margin pressure in Q4FY17. Input inflation has increased to 10.4% YoY from 3.5% in Dec’16 while output price inflation has marginally eased to 3.7% from 3.8% in Dec’16.
Total food inflation rose to 4.8% YoY, after bottoming at 2.8% in Jan’17, primarily driven by reversal in vegetables & fruits inflation from -14.7% in Jan’17 to 0.5% in Feb’17. Possibility of food inflation regaining momentum post demonetization and from expected sharper hike in kharif MSP, might keep the WPI inflation above 6%. Meanwhile FAO index also increased by nearly 17.2% YoY, excluding vegetable oil all other commodities increased. Fuel inflation rose to 21.0% YoY vs 18.1% in Jan’17, primarily due to rise in petrol and diesel inflation to 16.7% YoY and 33.1% respectively. Core WPI slightly eased to 2.4% YoY from 2.7% in Jan’17 primarily due to slight correction in ferrous metals inflation by 0.9% MoM to 8.4% YoY.
Outlook: Re-emergence of Inflationary pressures
In line with our expectations, once the initial reaction of demonetization fades out, the headline inflation is likely to gain momentum. This was clearly indicated by pipeline buildup in inflation as reflected in steady rise in WPI inflation, increase in global inflation (also indicated by sharp increase in Citibank’s global surprise index), stickiness in core CPI inflation and expected rise in government revenue expenditure at the centre & state level. The gap between the input and output price inflation (WPI) has increased in Q4FY17 which indicates that the margin pressure would remain. Evolving global conditions, signal rising inflationary pressure and end of an era of extraordinary low rates. We continue to expect CPI inflation rising closer to 6% by Mar’18, RBI to retain its neutral stance and 10 year Gsec yields to harden in the range of 7.5-7.8%.
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