Consumer Price Index (CPI) inflation was at 4.25% in May, the lowest in 25 months. With the price gauge now not too far from the Reserve Bank of India‘s target of 4%, it could be reasonable to see markets building up hopes of interest rates being lowered after a year of aggressive policy tightening.
However, the government bond market and the swap market – both of which are swayed by interest rate expectations – have not shown any signs of an imminent reduction in rates or for that matter a cut over the next six months.
CLOUDED INFLATION VIEW
The principal risk on the inflation front, one that has been persistently flagged by the RBI too, is the increasing likelihood of the El Nino effect, which is typically associated with weaker rainfall in India.
Recent reports quoted both the India Meteorological Department and private forecaster Skymet as pointing to stronger changes of the El Nino effect and consequently below-normal rainfall in June. Earlier this year, the IMD had predicted normal rainfall during the southwest monsoon season.
“The problem happens if you have a full-blown El Nino in the middle of July because July is a crucial month from a sowing perspective. That, I think, from a near-term perspective is the key risk to inflation,” Vivek Kumar, economist at QuantEco Research said.
PULSES, MILK
The largest concern emanates from food prices, which occupy a 46% weightage in the CPI basket. Economists flagged concerns about the prices of pulses and continuing pressure on milk prices which have witnessed significant increases since last year due to fodder price increases and lower production.
“There is definitely going to be an upside on the food inflation side, that is, on the primary articles. I am worried about pulses in particular. Inflation has already started increasing out there,” Madan Sabnavis, chief economist at Bank of Baroda said.
“If you have drought-like situations, even the allied activities get affected. If fodder prices go up, then milk prices go up. The worrisome thing is that any shortfall would lead to higher prices of manufactured products,” he said.
Inflation in milk and products was at 8.91% in May, while that of pulses and products was at 6.56%, official data showed.
NON-TRADABLE SERVICES
Analysts also flagged some aspects of non-tradable services, in which price pressures remained firm.
“Education, recreation, health, these are the things where the inflation has tended to increase last year and I’m not sure if that’s ended. Whether the inflation numbers go up will all depend upon the base effect. But absolute prices, month-on-month, I think there is still a lot of potential,” Sabnavis said.
Inflation in the education and health components was at 5.36% and 6.24%, respectively, in May, while that in recreation and amusement was at 3.69%.
In its Economic Survey released in January, the finance ministry observed that elevated inflation had been observed in household goods and services and personal care and effects due to a rebound in demand after the pandemic.
However, while retail inflation in health had moderated in FY23, inflation in education had surged after schools re-opened, the ministry noted.
The possibility of accelerated government spending in a pre-election year is another factor which warrants caution on inflation.
“Even if overall revenues do surprise higher, we don’t think that the government will save that excess revenue and show a lower fiscal deficit. They will likely spend that revenue. Especially if growth indicators start showing more meaningful slowing,” Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership said.