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Easing food inflation contributed the most in the moderation of headline inflation to 6.71%. Early signs of uneven monsoon and sowing data warrants caution on food prices, hence we see upside risks to food inflation in the near term. Core inflation continues to remain sticky at 6.25% with strong sequential gains (0.7%), indicating resilient demand which should sustain throughout the upcoming festive season before easing meaningfully. We believe India’s inflation trajectory is trending downwards mainly on account of the coordinated efforts of fiscal and monetary policy and recent easing in supply chains, with upside risks emanating from any escalation of geopolitical issues. IIP growth of 12.3% in Jun, exceeded expectations. Sequential gain in manufacturing (1.3%) was compensated by weakness in mining (-5.8%) and electricity (-1.5%). We see Q2FY23 inflation average at 6.9%, lower than RBIs 7.1%. With easing inflation, RBIs policy action would address INR depreciation than suppress demand hence rate hikes to be shallower (30bps) in Sep22.

* Inflation eases; upside risk to food inflation: CPI inflation moderated in July to 6.71% (7.01% prior) on expected lines, the categories which contributed the most in this moderation were food (6.75% vs 7.75% earlier) and transport & communication (5.6% vs 6.9% earlier). Sequentially, inflation moderated (0.46% vs 0.52% prior) across categories, except fuel (2%), housing (0.6%) and transportation (0.3%). Current easing indicates that the coordinated efforts of fiscal and monetary policy are taking shape. Although this moderation in food inflation was apparent from the softening mandi prices in July, but a similar decline in fuel prices (except non-subsidised LPG) has not transpired in the fuel index. Even the world FAO food index recorded steepest sequential fall of 8.6% (since Oct’08) in July, led by significant drops in vegetable oil and cereals. Going forward with the on-set of the festive season, we believe that food inflation should pick up in Aug’22; even the mandi prices have shown an uptick (till 12th Aug). We see upside risks to food prices due to floods and uneven monsoon, early indication of this can be seen in the decline (-12.4%) in latest sowing data, especially in case of paddy (-34%).

* Easing inflation; Shallower rate hikes: We believe India’s inflation trajectory is trending downwards while core inflation should be range bound (5.9% - 6.4%) throughout the upcoming festive season before easing meaningfully. But the risk of percolation of high WPI inflation to retail inflation would keep CPI elevated, currently the wedge remains as high as 8.2% and even if July WPI print eases by 50bps, the wedge would still be 8%. Although global supply chains may show early signs of easing, geopolitiacal issues are far from over and any further escalation would negatively impact crude price and INR. We see Q2FY23 CPI inflation at 6.9% vs RBIs 7.1%, easing inflation would entail a policy action adressing more towards defending INR than suppressing demand, hence Sep’22 MPC meet should see shallow rate hikes (30bps). With current repo rate (5.4%) already above the pre-pandemic levels (5.15%), we see the terminal repo rate at 6% for FY23.

* Favourable base lifts IIP growth; Manufacturing leads the show: IIP growth of 12.3% in Jun exceeded market expectations (10.7%), the double digit growth was on the back of a favourable base and was slightly better than the performance in eight core industries. On a sectoral level, highest growth was reported by electricity (16.4%) which was followed by manufactring (12.5%) and mining (7.5%). Momentum remained weak in Jun (0.1%), with a decline in mining (-5.8%) and electricity (-1.5%) while manufacturing gained 1.3% MoM. Growth (MoM) in manufacturing was led by tobacco (29%), computers (48%) and pharma (16%) while basic metals (-6.7%), food & beverages (-5%) and electrical equipments (-4.3%) dragged the index. On use-based sectoral level, capital goods (7%), consumer durables (9.3%) and non-durables (6.5%) witnessed highest sequential gain while primary goods (-3.8%), intermediary goods (-2.9%) and infra goods (-2.7%) weakened. We see IIP growth to normalise going forward, as base effect fades from next month.

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