Retail Inflation At 5.77%; May Not Be As Scary As It Looks
Jul 13, 2016

Author: PersonalFN Content & Research Team

The RBI and Government have mutually agreed to work towards achieving the target of 5.0% on retail inflation by March 2017. Going by the inflation numbers for the first 3 months of the Financial Year (FY) 2016-17; it looks like the Government and RBI may struggle to achieve the target. Retail inflation, measured by the movement of Consumer Price Index (CPI) has spiked to 5.77% to touch a 22-month high. At 7.79% food inflation looks worrisome too.

Sharp rise in inflation…

(Source: MOSPI, PersonalFN Research)

What's driving inflation up?
From March 2016, the retail inflation has jumped 94 bps (basis points) while the food inflation has recorded a massive 258 bps increase. A basis point is 1/100th of a percent. Within the Food and Beverages category, Meat and Fish, Vegetables, Pulses, and Sugar have witnessed an upsurge in prices in the past 3 months. The categories mentioned above have been the primary drivers of not only the food inflation but also the overall CPI inflation. As per the estimates of Financial Express dated July 13, 2016, share of price rises in Vegetable category in CPI inflation has increased incessantly from 1% in March to 17% in June. In simple words,for every 1% rise in CPI inflation, 0.17% can be attributed to Vegetables specifically, as far as the CPI reading in June goes. If you add up the price escalations experienced in Meat and Fish, Pulses, and Sugar; it becomes apparent that food inflation has driven the retail inflation almost single-handedly in Q1, FY 2016-17.

But a ray of hope...
Core inflation (non-food inflation) has remained benign between March and June. Average price rises in the four broad categories in core inflation namely, Clothing and Footwear, Housing, Fuel and Light and Household Goods and Services have been 5.36%, 5.37%, 3.07% and 4.75% respectively between March 2016 and June 2016. This suggests that core inflation component has remained relatively stable as compared to the food inflation component.

Will food inflation abate?
Dropping levels of water reservoirs and seasonality have been the primary drivers of the sharp rising vegetable prices. As compared to those in winter, prices of vegetables usually rise in summers. Satisfactory monsoon is likely to have a positive impact in driving the vegetable prices down. Moreover, state Governments have also been taking initiatives to control the cost escalations. Maharashtra Government recently amended in the Agricultural Produce Marketing Committee (APMC) Act due to which the monopoly of APMC licensed traders and commission agents in deciding the prices of vegetable and fruits will come to an end now. Farmers will be able to market / sell the produce themselves. This might turn out to be a win-win situation for both—farmers and the consumers. Nationwide impact of such moves can’t be ruled out. Onion prices that bring tears to the eyes of the common man at least twice or thrice a year are decided in APMC-controlled Lasalgaon market in Maharashtra. If delisting of fruits and vegetables from APMC bears good results in Maharashtra, other states may also follow suit. Initiatives of the Central Government to improve the supply of pulses in the country might help to dampen the pulses prices. Recently, the Government announced higher Minimum Support Price (MSP) and offered bonuses to encourage the sowing of pulses. As a result, the production of pulses is expected to improve by over 17% this fiscal—a positive to bring down pulses prices.

The impact of 7th pay commission on non-food inflation?
The Seventh pay commission is going to provide a stimulus of around Rs 84,900 crore to the economy of which nearly Rs 47,000 crore will be ploughed back into the economy by way of spending. Such a massive infusion of liquidity is expected to push core retail inflation up as consumers will have a better purchasing power leading to the higher demand for consumer goods such as automobiles and consumer durables. Historically, the real estate demand also rises when Government employees get pay hikes. How badly will the non-food component be affected? Well now, it’s anybody’s guess. The industry hasn’t been operating at optimally so unutilized capacities will absorb the higher demand for at least some time. On this backdrop, consumer confidence holds the key. Higher inflation expectations due to higher food prices may dampen the consumers’ confidence. The picture might become clear over the next few quarters.

How the RBI might interpret this?
As you are aware, Dr Rajan is going to say sayonara to RBI this September. There is a growing speculation that the new RBI Governor may be more dovish in the policy stance. Now onwards, the Monetary Policy Committee (MPC) will decide policy rates and not the RBI Governor alone, although he would still have a final say in case the committee remains undecided on the strategic direction. MPC will have 3 Government representatives. How they take a stand in deciding policy rate movement is also crucial. Any instance of group thinking may mar the fundamental purpose of having an MPC. Therefore, how MPC reads inflation numbers will largely depend on how the Government representatives and the RBI representatives read the developments in food inflation and nonfood inflation. If Government appointed members feel optimistic about steady non-food inflation and RBI officials feel pessimistic about higher food inflation, there is a possibility of a clash of opinions. Under such circumstances who is the RBI Governor will matter a lot since he will have a deciding vote on the policy stance.

How have capital markets reacted to higher inflation?
There’s not much of a negative reaction to higher inflation in the markets mainly because the markets were expecting the inflation to move up. Bond markets are more anxious about the selection of RBI Governor at the moment, which is why retail inflation numbers haven’t influenced them much. On the other hand, equity markets have been expecting better quarterly results, this time. Hence, they are mostly unmoved by the higher CPI inflation.

What investors should do?
As always, PersonalFN believes you would be better off if you don’t speculate on any macroeconomic trend or an event such as monetary policy announcement. Rather, you should bother more about your financial goals and the current financial health when deciding where to invest your hard earned money. The best approach is to follow your personalised asset allocation that takes into account your financial goals and risk appetite.