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Surge in food, fuel prices push CPI to 6-month high of 6.3%

* CPI surprises to the upside; rises to 6-month high of 6.3% in May 2021:

India’s retail inflation inched up to 6-month high of 6.3% in May 2021, exceeding consensus and our estimate by 80-100bps. In Apr 2021 and May 2020, CPI had come in at 4.2% and 6.3% respectively. This print gives credence to the warning sounded off by RBI staff a couple of months ago that the second wave of Covid-19 could be inflationary. Almost all subcomponents of CPI basket recorded higher-than-expected inflation. With this print, average inflation in the first two months of FY22 stands at 5.3%.

* In y/y terms, rising fuel and services costs compensate falling food prices:

Although headline CPI inflation stood at 6.3% in both May 2021 and May 2020, the internals were quite different. In May 2020, food contributed 380bps out of the total inflation of 630bps while fuel and services contributed 10bps and 160bps respectively. This was mainly due to the supply and transportation constraints faced during the early months of nationwide lockdown. However, in May 2021, food contributed only 240bps out of the total inflation of 630bps while fuel and services contributed 80bps and 210bps respectively. This shows that while supply constraints may not have been as severe during the second wave compared to the first wave, the persistent rise in fuel prices and costlier services have kept inflation high.

* In sequential terms, increase in inflation driven by food, services, fuel:

However, contrary to year-on-year inflation, all three factors viz. food, fuel and services contributed to the rise in sequential inflation. Food inflation surged to 5.2% in May 2021 from 2.6% in Apr 2021, fuel inflation increased to 11.6% from 8% while services inflation increased to 7.5% from 6.1%. Within food, oilseeds and fruit prices continued to surge, contributing heavily to the rising inflation. We expect prices of these two items to remain elevated in the near term.

* Month-on-month momentum contributes ~80% of the increase between May and Apr 2021; base effect contributes only 20%:

The base effect for May 2021 was unfavourable as inflation between May 2020 fell to 6.3% from 7.2% in Apr 2020. However, bifurcation of CPI print for May 2021 into base effect and month-on-month momentum shows that, out of the 210bps increase in inflation between May 2021 and Apr 2021, base effect contributed only ~20% while month-on-month momentum contributed ~80%. Hence, the increase in inflation in May 2021 is credible, genuine and is driven by uptick in monthly prices.

* Core inflation surges to 6.7%, highest since May 2014:

Our measure of core inflation (ex food, fuel) increased to 6.7%, up from 5.5% in Apr 2021 and 5.1% in May 2020. This is the highest reading of core inflation since May 2014 and indicates that the underlying price pressures are credible and persistent. Within the core basket, healthcare and transportation costs have surged, driving the rise in core inflation. Healthcare inflation jumped to 8.4% in May 2021 from 4.1% in May 2020 as high demand for medicines and life-saving drugs led to increasing prices amidst the pandemic. Transportation inflation also surged to 12.4% in May 2021 from 6.1% in May 2020 on the back of rising fuel prices.

* Inflation likely to overshoot MPC’s projections:

The higher-than-expected inflation print for May 2021 calls for revising inflation forecasts for FY22. As per the latest MPC forecasts, inflation is expected to average 5.2% in Q1FY22. However, in the first two months of FY22, inflation has averaged 5.3%. Hence, we expect actual inflation prints to exceed the MPC’s forecasts at least in Q1FY22.

* IIP grows 134% in Apr 2021 on low base:

In a separate data release, the index of industrial production (IIP) grew 134.4% in Apr 2021, mainly due to low base. In Apr 2020, the nationwide lockdown led to IIP contracting 57%. In Mar 2021, IIP had grown 24%. As expected, manufacturing sector (which had contracted the most in Apr 2020), posted the strongest growth among the three sectors. Manufacturing sector grew 197% in Apr 2021 while mining and electricity sectors grew 37% and 8.5% respectively. From the use-based perspective, consumer durables, capital goods and infrastructure/construction goods posted the strongest growth. We expect low base to keep IIP growth high in the next 3-4 months.

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