Published on 14/11/2017 4:46:53 PM | Source: Emkay Global Financial Services Ltd

Inflationary concern to augment in Q4 - Emkay

Retail inflation in Oct’17 increased to 3.6% yoy, however it is tad lower than our expectation of 3.7%. Overall build up in inflation remained strong and was broad based. Food inflation particularly vegetables inched up further this month, this trend will further intensify in Nov-Jan’18 as the last year’s base of demonetization sets in. Even with recent ease in GST rates, we do not expect any significant respite in core inflation. On the contrary, we believe core CPI to strengthen further to an average of 5.3% in Q4FY18 on higher commodity prices and improvement in demand sentiment. Observing CPI print, we believe WPI for Oct’17 is likely to increase to 2.7% yoy, marginally higher than 2.6% in Sep’17. We believe, RBI would be cautious on the inflation print as the international commodity prices has gained momentum and domestic pressures also remain imminent. With inflationary pressure hardening and reduction in excess liquidity in the system, we believe rate easing cycle has come to an end.

Core inflation stagnated at 4.6%

Core inflation remained at 4.6% yoy, the print has been nearly similar in last three months, and however it is significantly higher than recent bottom of 3.9% in Jun’17. Increase in rental yields due to implementation of HRA allowances has pushed the housing inflation to 6.7% yoy in Oct’17, i.e. an increase of 449bps from Jun’17. Overall contribution of miscellaneous services to the headline inflation moderated to 26% from 31% in Sep’17. Transport & communication inflation slowed to 2.3% yoy due to reduction in petrol prices by nearly 3.3% yoy. Reversal in crude prices in November is likely to either result in sharper hike in petrol and diesel inflation or it might be somewhat mitigated by reduction in excise duties.

Food inflation increased further to 1.9% yoy in Oct’17 from a low of (2.1)% in Jun’17. Increase in food inflation is mainly on account of reversal in vegetables inflation to 7.5% and steady increase in milk prices. Pulses inflation continued to decline, as it further contracted by 23.1% yoy. Global food prices, as indicated by FAO index, slowed to 2.5% yoy in Oct;’17; except for cereals all other commodity prices fell in October.

Divergent trend was observed between fuel inflation which increased to 6.4% (due to base effect) and transport & communication inflation which eased to 2.3% YoY

The wedge between CPI inflation at rural and urban increased in Oct’17 to 45bps as urban inflation increased to 3.8% yoy and rural to 3.4% in Oct’17. The divergence is primarily due to higher vegetable and housing inflation in urban areas.

Outlook: RBI to turn cautious on rising inflationary pressure

The retail inflationary pressure has continued to build up in Oct’17 after bottoming out at 1.5% yoy in Jun’17. According to the diffusion index nearly 82% of the broader components within CPI witnessed an uptick in Oct'17. We believe that the food inflation particularly vegetables might continue to augment with much lower base of last year (one offs such as demonetization), the vegetable inflation might be in double digit in Dec-Jan’18. Also, strengthening in crude oil prices is likely to have a pass through impact on other components of inflation as well. Going forward, we believe that with remonetisation, higher government spending and higher global commodity prices, CPI will move in tandem with core inflation. We expect CPI and core CPI inflation to be on an average at 4.7% yoy and 5.3% respectively in Q4FY18. This expectation is beyond RBI’s comfort range of 4.2-4.6% in H2FY18. Based on hardening inflation outlook, we believe RBI would refrain from further rate cuts and would maintain its neutral stance.


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