CPI inflation accelerates in July, largely led by higher food prices:Headline CPI inflation picked up further to 6.1% in July, compared with 5.8%YoY registered in the previous month. This was largely in line with ourexpectation. Core inflation also accelerated to 4.6% YoY (vs 4.4% YoY inJune). We expect CPI inflation to moderate towards 5% by Mar 2017 andaverage ~5.3% YoY in FY17. We believe the good progress of monsoons, adeferred hike in allowances under the 7th Pay Commission, sluggish globalcrude oil prices and a gradual domestic demand recovery will likely keepinflationary pressures contained, barring the seasonal variation in FY17.
Scope for policy easing in FY17: We believe there’s scope for furthermonetary easing by another 25-50bp in FY17, assuming a dovish RBIgovernor and MPC (monetary policy committee) members and containedinflation. However, the space will get constrained in FY18 as upside risks toinflation follow from GST implementation, house rent allowance (HRA)increases under the Pay Commission award, closing of output gap andsupply-side bottlenecks. We believe the pace of transmission of a policy ratecut in terms of lower lending rates by scheduled commercial banks will remainthe key focus of policymakers, and for that, banking sector reforms are critical.
Policy continuity is key: We believe announcement of a new RBI governor(considering Dr Rajan’s term ends in the first week of Sep 2016), selection ofMPC members (mainly 3 government-appointed members) and progress ofmonsoons and its impact on sowing pattern for summer crop will be key towatch over the coming weeks and will have an impact on the policy outlook.
Higher food inflation (8% YoY vs 7.5% YoY in June) pulls CPI inflationup: Looking at the breakdown, the increase in food inflation in July waslargely led by higher prices of cereals (3.9% YoY vs 3.1% YoY in June), sugar(21.9% YoY vs 16.8% YoY in June) and milk products (4.1% YoY vs 3.4%YoY in June). While the prices of pulses remained elevated, somedeceleration was seen in case of vegetable prices. The firming in sugar priceshas been largely due to a decline in domestic production after 2 successiveyears of drought. We expect food inflation to start softening over thecoming months as fresh supplies (mainly of vegetables and pulses)start hitting the market and active food supply management by thegovernment. It is worth noting that the government has been trying to keepdomestic prices of pulses contained by resorting to imports, stepping up dehoardingoperations, imposition of stock limits and sale at government-ownedretail/fair price outlets at subsidised prices.
Core CPI inflation (CPI ex food and ex fuel inflation) accelerates to 4.6%YoY (vs 4.4% YoY in June). However, it needs to be noted that two majorenergy components, mainly petrol and diesel, are part of transport andcommunication, which cannot be further segregated. This limits the estimationof CPI core inflation based on statistical techniques other than exclusion. Thepick-up in core inflation was largely led by higher prices of personal care andeffects segment (7.3% YoY vs 5.9% YoY in June) under servicesconstituents.
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