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7Inflation: Decoding the underlying coreApr-04-2018

Inflation: Decoding the underlying core

Blog by – Mr. Ashish Ajmera
A continued upward pressure on core inflation seems to be becoming an inherent feature of the local economic scenario in recent months. Core inflation (manufactured products excluding foods products) accelerated to 42-months high of 3.9% in February 2018 from 3.4% in January 2018. With the economy showing signs of a steady recovery, the continued increase in core inflation can weigh on the central banking monetary policy and would have to be closely watched in near term. Key risks to the retail inflation include higher Minimum Support Prices (MSP) for agricultural items, populist spending in the run-up to the 2019 general elections and strengthening of global crude oil prices, the ASSOCHAM has said in its pre-credit policy review letter to the Reserve Bank of India (RBI).

ASSOCHAM Secretary General D S Rawat`s letter to the RBI Governor, Urjit Patel has said though consumer price index (CPI) showed a decline in retail inflation to 4.44% in February from 5.1% in the previous month, the key risks to the base case CPI inflation forecast include higher Minimum Support Prices (MSPs), global crude oil prices strengthening further and populist spending in the run-up to 2019 general election. It said the chamber appreciates Reserve Bank of India (RBI) for maintaining status quo in the previous Bi-Monthly Monetary Policy Statement and keeping the policy repo rate under the Liquidity Adjustment Facility (LAF) unchanged at 6%. Consequently, the reverse repo rate under the LAF remained at 5.75%, and the marginal standing facility (MSF) rate and the Bank Rate at 6.25%.

WPI inflation eases to seven-month low of 2.5% in February 2018
The Wholesale Price Index (WPI)-based inflation, base year 2011-12, eased further down to a seven-month low of 2.5% in February 2018, while exhibiting a decline for the third straight month from 2.8% in January 2018. Among the three major components of the WPI index, the inflation for primary articles dipped sharply, while fuel & power group inflation also eased contributing to the decline in overall inflation in February 2018. However, the inflation for manufactured products group moved up in February 2018.

Core inflation (manufactured products excluding foods products) accelerated to 42-months high of 3.9% in February 2018 from 3.4% in January 2018. Inflation of primary articles dipped to 0.8% in February 2018 from 2.4% in January 2018, while the inflation for fuel items eased to 3.8% in February 2018 from 4.1% in January 2018. However, the inflation for manufactured products rose to 3.0% from 2.8%.The all-India general consumer price index (CPI) inflation dipped to four-month low of 4.44% in February 2018, compared with 5.07% in January 2018 and at 3.65% in February 2017. However, the core CPI inflation rose marginally to 5.04% in February 2018 compared with 5% in January 2018.

Cost inflation accelerating, demand factor remains supportive
However, the trends in coming months are likely to be different as demand factors could come into play amid improving economic conditions and steady increase in disposable incomes. Elevated global prices of metals, energy and other key raw materials would prompt the supplies to increase prices while demand would also hold on, leading to a buildup of inflationary pressures. The Nikkei India Manufacturing Purchasing Managers Index (PMI) fell from 52.4 in January to 52.1 in February. The PMI registered above the neutral 50.0 threshold for the seventh consecutive month and indicated a modest improvement in operating conditions. The overall upturn was driven by increasing output and new orders, but both registered at slightly slower growth rates. In response to greater production requirements, firms raised their staffing levels and purchasing activity. On the price front, cost inflation accelerated to the fastest since last February. Meanwhile, manufacturers raised their output charges as part of attempts to pass through higher cost burdens to clients. Input costs increased for the twenty-ninth month during February, with panellist reporting higher prices paid for steel, chemicals and fuel. Manufacturers raised their output charges during February, thereby extending the period of inflation to seven months. Where selling prices were raised, there were reports of passing on higher cost burdens to clients.

Indices stumble, economy looks up
While the local equities slid over last two months, the economic data releases have been generally good. The banking sector woes seem to be continuing following the PNB scandal and global markets are gyrating to the tune of trade war fears. However, on the economic data front, the leading indicators have been largely supportive for the domestic macro economy. Local data has signalled an economic turnaround recently. India`s industrial production (IIP) continued to record a strong growth for the third straight month at 7.5% in January 2018 from 7.1% growth in December 2017. The manufacturing sector`s production surged 8.7% in January 2018, supporting overall growth in industrial production. Sixteen of the 23 industry groups in the manufacturing sector showed growth. The use-based classification showed that production of primary goods rose 5.8 percent, while capital goods output increased 14.6%.

RBI keeps interest rates at 6% for the third consecutive policy meeting
The Reserve Bank of India (RBI) has already expressed some concerns on price rise. The RBI kept interest rates at 6% for the third consecutive policy meeting in early February 2018. Five of the six members of the MPC voted in favour of keeping rate unchanged, while one member, M.D. Patra, wanted a rate hike of 25 bps. While holding rates, the central bank said the stance of the policy remained neutral. Household’s inflation expectations, measured by the Reserve Banks survey of households, remained elevated for both three-month ahead and one-year ahead horizons even as inflation expectation for one-year ahead horizon moderated marginally. Firms responding to the Reserve Banks Industrial Outlook Survey (IOS) continued to report input price pressures and increase in selling prices in Q3. This is also confirmed by manufacturing and services firms polled by PMI. Organised sector wage growth remained firm, while the rural wage growth decelerated, noted the RBI.

The recent downtick in headline inflation notwithstanding, it is very much likely that the underlying pressures on prices are about to pick up after a benign trend in last fiscal. Inflation in the country continued to moderate during 2017-18. Consumer Price Index (CPI) based headline inflation averaged 3.3% during the period which is the lowest in the last six financial years, according to the Economic Survey 2017-18. The decline in the inflation was broad-based across major commodity groups except Housing and Fuel & Light. The Headline inflation has been below 4% for twelve straight months, from November, 2016 to October, 2017 and CPI food inflation averaged around one per cent during April-December in the current financial year, stated the Survey. The Survey observed that the economy has witnessed a gradual transition from a period of high and variable inflation to more stable prices in the last four years. Headline inflation measured by the CPI has remained under control for the fourth successive year, stated the survey.

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