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CPI inflation (7.4%) exceeding market expectations in Sep’22, was mainly led by high food prices. Latest mandi prices indicate subdued price pressures in food category (till 10 Oct) hence moderation in food inflation cannot be ruled out in Oct. Uptick in prices due to festive demand was not limited to food category but was also evident in Clothing (9.9%) and footwear (12.3%), indicating strong demand environment helped firms exercise pricing power. Manufacturing and Mining drag IIP in Aug’22, while robust growth in Cap goods and infra bodes well for Capital investments but de-growth in consumer durables and non-durables may be indicating slower demand expectations by firms. We believe RBIs policy action would be equally guided by Feds rate actions and by domestic growth and inflation mix. We expect RBI to hike policy rates by 30-35bps in Dec with an upside risk of 50bps and accordingly raise our terminal repo rate estimate to 6.5% for FY23.

Festive demand led inflation:

Headline inflation (7.4%, 7% prior) exceeded market expectations of 7.3% in Sep’22. Food prices had the highest contribution to the headline inflation (Ex 2). The uptick in prices due to festive demand was not limited to food category but was also evident in Clothing (9.9%) and footwear (12.3%), indicating firms excercising pricing power due to strong demand environment. Energy inflation continued to remain elevated (10.4%) since last four months. Excluding vegetables, inflation would be 6.7% in Sep’22 which is marginally higher than 6.6% in Aug’22 while food inflation surged by 8.4% in Sep’22 from 7.6% in the previous month. We expect food prices to remain elevated during Oct’22 as festive season would continue till the end of the month, however mandi prices have remained subdued (till 10th Oct) hence a moderation cannot be ruled out.

Core Inflation remains sticky:

: Although Core inflation (Net of food, fuel and intoxicants) surged 6.26%, it has remained in the range of 6.2 - 6.26 since last three months. Which indicates that the headline inflation is at elevated levels due to the volatile components in the CPI basket. Moderation in miscellaneous inflation and prices of personal care items was compensated by uptick in clothing and footwear category. We believe that core inflation should countinue to be in this range (5.9% - 6.4%) throughout the festive season before easing meaningfully as demand moderates

Manufacturing and Mining drag IIP:

IIP de-grew by 0.8% in Aug’22, much below the market expectations of 1.7%. Electricity was the only sector to register growth (1.4%) while manufacturing (0.7%) and mining (3.9%) declined. The fall in manufacturing as per IIP is in contrast to the findings as per the manufacturing PMI in Aug, where firms reported output growth on the back of strong domestic demand. Within the use based classification, robust growth in capital goods and infra segment bodes well capex in the economy. While de-growth in consumer durables (2.5%) and non-durables (9.9%) may be indicating that firms see slower demand environment. Within manufacturing, items which dragged the index were textiles (12%), wearing apparel (18%), pharma (19%) and electrical equipment (28%) while growth was reported in motor vehicles (24%) and chemicals (5%).

RBIs policy action to be guided by Fed:

: The uptick in food inflation was led by festive demand, which we expect to moderate post Oct as the festive demand fades. With this print, Inflation averaged 7% in Q2 vs our expectations of 6.9% but remained lower than the RBI estimates of 7.1%. RBI expects inflation to moderate to 6.5% in Q3FY23. Going forward, we believe RBIs policy decision would be equally guided by Feds rate actions and by domestic growth and inflation mix. We believe inflation has peaked in Apr’22, and is trending downwards, manufacturing PMI also reflects similar observation wherein firms reported lower input cost inflation with the easing in supply disruption and this phenomenon is observed across the economies. We raise our terminal repo rate estimate to 6.5% for FY23 from our earlier estimate of 6%, moreover we expect RBI to hike policy rates by 30-35bps in Dec with an upside risk of 50bps.

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