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Unfavorable base effect-led rise

* Dec’21 headline CPI inflation rose to 5.6% (4.9% in Nov’21) due to an unfavorable base effect, even as food inflation moderated sequentially, led by vegetables. Mandi prices suggest that vegetable prices will continue to fall. Imported food costs stayed high. Core inflation eased mildly to 6.15%with easing momentum as the impact of the telecom tariff hike was offset by the tax cut-led decline in motor fuels, while other core components eased mildly on a sequential basis.

* We see FY22 inflation at 5.4% (RBI: 5.3%) with risk largely balanced. Even with food inflation averaging around reasonable levels, core inflation will average ~6.0%, outdoing headline. We remain watchful of inflation push-and-pull factors such as 1) volatility in vegetable prices, 2) some correction in global commodity prices, 3) early signs of easing supply chains globally (and a possible reversal of the same amid Omicron’s spread), 4) contained household inflation expectations, and 5) the impending demand revival.

* The inflation-led dissenting noises in the MPC may continue and so do the liquidity repricing by stealth. We reckon the monetary reaction function is currently hinging more on growth revival becoming sustainable, but a rapid change in global dynamics and a swift move in the Fed’s reaction function could tie the RBI’s hand this year – contingent upon global volatility.

CPI inflation rises sharply led by unfavorable base effect

CPI inflation increased to 5.6% yoy in Dec’21 from 4.9% in Nov’21, largely owing to low base effects. The print was much lower than consensus (5.8%) and our expectations (5.87%). Food prices moderated sequentially, while lower fuel costs offset the increase in telecom tariffs. Within food, there was largely a broad-based weakness seen sequentially, even as the base effect led to a higher annualized print of 4.5% yoy. While prices of vegetables (-5.4% MoM – led by seasonality), edible oil (-1.3% MoM – led by tax cuts) and some of protein-complex (pulses, meat and fish) eased, prices of components like cereals, egg and milk rose. High-frequency mandi prices suggest a further sharp decline in vegetable prices, led by tomatoes and oilseeds. Energy inflation, although high at 11% YoY, has declined for the third month in a row, with a sequential gain of 0.12% MoM.

Core inflation eases but momentum gains due to telecom hikes

Core inflation (ex food, fuel and intoxicants) moderated to 6.16% (6.30% prior). The tax cut-led decline in motor fuels was offset by a sharp rise in telecom tariffs. Personal care & effects, healthcare and education eased moderately. Housing rentals declined due to the December statistical effect. We expect the core inflation momentum to remain healthy, as firms may choose to pass on persisting higher input costs in a recovering economy, implying that the YoY print will hover a tad below 6% through Q4FY22.

IIP growth moderates with sequential weakness; poor show by Manufacturing

IIP grew by a meagre 1.4% in Nov’21 (Emkay: 2.2%; Consensus: 2.8%) vs. upwardly revised 4% growth prior. This has led to a decline in output again to slightly below pre-Covid levels. There was a broad-based weakness, led by manufacturing, which barely grew (0.9% YoY, contracting 4.8% MoM) led by segments like motor vehicles, transport equipment and electrical, and chemical products. This was reflected in the easing manufacturing PMI (55.5). Mining and electricity grew 5% and 2.1% YoY, respectively. Use-based, capital goods (-3.7% YoY) and consumer durables (-5.6% YoY) contracted, while growth was seen in Infra (3.8%), primary goods (3.5%), intermediate goods (2.5%) and non-durables (0.8%), with a sequential decline across sectors. High-frequency data in the past few weeks suggests some easing in economic activity due to mobility restrictions, and could weigh mildly on Q4 growth.

FY22 CPI to average 5.4%; noises within MPC to rise but limited action expected in near term

Going ahead, headline inflation will continue to stay close to the higher end of the inflation target amid the base effect and the possible pass-through of input costs, while a pullback in global commodity prices, mild reversal in core price pressures, early signs of easing in supply chains globally and contained household inflation expectations could offset the same. While the actual print came in a tad lower than the RBI’s forecast (5.0% vs. 5.1%), we see inflation averaging 5.4% - a tad higher than the RBI’s estimates. In our view, the inflation-led dissenting noises in the MPC may continue, and with global policy normalization picking up pace in a fast fashion, monetary policy would continue to adjust via stealth as it is currently hinging more on growth revival becoming sustainable.

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