Ind-Ra expects inflation to remain nonthreatening over the next few months mainly due to a sharp fall in global commodity prices including crude oil; supply of winter vegetables; the favourable base effect. The annual rate of inflation, based on Wholesale Price Index (WPI) declined to 1.8% in October 2014 from 2.4% in September 2014.
This is the lowest level of WPI inflation witnessed since October 2009. The drop in WPI inflation has been broad based as all the three major components namely primary commodities, fuel & power and manufactured products have shown decline in October 2014. Even the Consumer Price Index (CPI) based inflation moderated to 5.5% in October 2014 from 6.3% in September 2013. This is the lowest level since January 2012 when the compilation of inflation based on new CPI combined series started.
Ind-Ra holds on to its view that the Reserve Bank of India (RBI) is unlikely to cut policy rates in the fifth monetary policy review scheduled in December 2014. In its fourth bi-monthly monetary policy statement on 30 September 2014, the RBI kept the policy repo rate under the liquidity adjustment facility unchanged. No doubt, the declining inflation has increased the headroom for the RBI to act on policy rates. However, the trajectory of inflation/inflationary expectations is still somewhat fuzzy in view of waning of base effect after December 2014 and absence of clarity with respect to commodity particularly crude prices. However, a rate cut looks like a possibility in February 2015 provided the inflation data is not a surprise on the upside.
Food inflation, which had been one of the key drivers of inflation over the past few years, fell to 2.7% in October 2014 from 9.6% in May 2014. This is the lowest data print for food inflation since February 2012. However, there are still certain food items which are witnessing very high to high double digit inflation for past several months. For example, over the past six months, inflation in fruits has ranged between 19% and 31%, in milk between 9% and 12% and in potato between 37% and 90%.
Despite a considerable decline in the headline WPI and CPI inflation, the risk has not fully subsided because of the inflation dynamics. At the current juncture, it is a mix of both structural and seasonal factors. While seasonal factors could have a transient impact leading to sharp swings in the headline inflation in either direction, structural factors keep inflation stubborn; concerted efforts will be required over the medium term to sustain inflation at low levels. Some of the structural factors that are impacting inflation are stagnating productivity, rising cost of cultivation, changing food consumption pattern and supply shock being exploited by intermediaries.
Manufacturing inflation came in at 2.4% in October 2014 (September 2014: 2.8%). Manufacturing inflation has been falling since July 2014 when it was 4.1%. The manufacturing sector recovery is uneven across the use-based segments; the sector is still not out of the woods. Therefore, Ind-Ra believes it is unlikely that manufacturers will be able to exercise their pricing power and manufacturing inflation will remain benign in the foreseeable future.
The strength of the US dollar (as measured by the US Dollar Index) and low global demand, are pushing commodity prices to lower levels. The price of the Indian crude basket declined to USD78.92 per barrel on 12 November 2014 from USD104.56/bbl on 1 April 2014. Most commodity prices (edible oil, gold, silver etc.) have declined between April 2014 and October 2014.