Taking a note of the unusual spike in the inflation during April this year, the RBI kept policy rates unchanged at its second bi-monthly monetary policy review meet on June 7th . Although the tone of the monetary policy was accommodative, it was concerned about the faster-than-expected price increases and the consequential effects on inflation expectations of corporates and households. The RBI felt there’s a 70% possibility that the inflation may move between 3.5% and 7.0% in this fiscal. It seemed to be foretelling what was in store for us. In May, retail inflation measured by the movement of Consumer Price Index (CPI) has jumped to 5.76% as compared to 5.01% recorded a year earlier.
 

Food inflation worsens in May

(Source: MOSPI, PersonalFN Research)  

As per the Government data, there’s been an across-the-board upsurge in inflation. The biggest worry has been the food inflation, which has shot up 7.55%. In May 2015, the food inflation advanced at 4.80%. Inflation in the ‘clothing and footwear’ category has jumped 5.37% and that in ‘housing’ has advanced at 5.35%. Inflation in education and healthcare stood at 5.85% and 5.10% respectively. Within the “Food and beverages” category, the rate of inflation remained as under:
 

What propelled food inflation?

Description of an item	The rate of inflation in May (%)
Meat and fish	8.67
Egg	9.13
Vegetables	10.77
Pulses and products	31.57
Sugar and Confectionery	13.96
Spices	9.72

(Source: MOSPI, PersonalFN Research)
What are the upside risks to the inflation that still haunt us?

• International commodity prices have been rebounding sharply.
• The impacts of the implementation of the 7th Pay Commission are still not factored in.
• Even after adjusting for the seasonality factors, upswing in the prices of a number of food articles looks unusual.

However, why you shouldn’t be overly concerned?

• The reservoir levels this summer were unusually low and this has mainly impacted the vegetable prices.
• Despite the lower crop in the Rabi season, the food stock at 58 MT was almost three times the norm for Q1, as the RBI describes.
• Although the first-stage long range forecast for the monsoons had predicted above average rainfall for this season in April, the second stage more reliable forecast came forth only in the first week of June. Thus, the May inflation data didn’t factor in this information.
• Recently, the Government announced moderate hikes in the Minimum Support Prices (MSPs) for this season with special incentives for pulses and oilseeds. This too hasn’t been captured in the May data analysis.
• Further, taking a serious note of the surge in food article prices, the Government has been trying to quickly fix the problem by applying prudent measures to ease the supply of stock.

What are the factors to watch out for

• Progress of monsoon
• Response of the Government to the current inflation numbers.
• How RBI reads the numbers

 

Impact of the rise in inflation on monetary policy measures
Although the RBI remains reasonably confident of curbing the inflation to 5.0% by March 2017, it has become more cautious and attentive to the upside risks emanating from higher food and services inflation. While the Central Bank expects the Government to facilitate the improvement in the supply of services, it is also watchful to the macroeconomic factors such as, performance of agriculture and inflation expectations among others. Also, it would expect banks to pass on the benefits of previous rate cuts to the borrowers.

What’s the implied message for the investors?
The RBI had slashed the policy rate by 150bps since January 2015, of which banks have passed on only about half to their borrowers. Rising inflation has nearly ended the remote hope of rates being cut generously in the near future. For now it appears that, RBI will be happy to hold rates unchanged. The risk associated with investing in debt funds has heightened. Higher inflation is a new phenomenon and hasn’t been fully priced-in. If inflation gives no respite, there will be a selling pressure in bonds. Fortunately, the liquidity isn’t tight which, if it had been, would have made things worse for bond fund investors.

This is why PersonalFN always recommends that investors should consider their time horizon and risk appetite before investing in debt funds.
 

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