Inflation Update - January 2011

WPI inflation for Jan 11 at 8.23% (yoy) was above consensus expectations of around 8.1%. The WPI inflation for the month of Dec 10 was at 8.43% (yoy). For the current month, rise in manufactured products inflation has turned out to be much stronger than the expectations and also the trend seen so far. The inflation for Nov 10 was revised higher to 8.08% from the provisional estimate of 7.48%. The revision was sharply upwards under food articles and the non-food manufactured products. Since the time of introduction of new index, the revisions have been upwards and sharper every next month. The quantum of upward revision on the y-o-y headline inflation has widened from 0.3% in Aug 10 to 0.6% in Nov 10. Apart from higher provisional numbers, such sharper upward revisions pose a greater threat to the outlook on monetary policy.The m-o-m rise in headline WPI was clocked at 1.25%, which is substantially higher than 0.70% mom growth observed previous month. The m-o-m rise is also the sharpest since April 2010. Hence, the current slide in annual inflation numbers, from 8.43% (Dec 10, yoy) to 8.23% (Jan 11, yoy) is purely a factor of a high statistical base. The Primary Articles index too has seen a sharp jump in index by 2.4% (mom), which again is the sharpest since April 2010. The weekly readings in Jan 11 had seen considerable upside on food prices tracking seasonal disturbances on the supply side. But, the last week of Jan 11 saw considerable softening in the prices of food articles, marking improvement in the supply conditions. The food prices, thus, are expected to soften further, giving downward thrust to the inflation readings. However, before one gets comfortable with softening of food prices, it is also interesting to note that the current month’s rise in non-food articles at 3.7% (mom) is much higher than the rise in food articles at 2.03% (mom). Therefore, along with food prices, the developments on non-food articles would also need to be watched avidly. The Fuel index has risen by 0.8% (m-o-m) in Jan 11, a slowdown from increase of 1.0% seen previous month. The upside on index is primarily on account of a substantial rise in prices of petrol (4.6%, mom) and aviation turbine fuel (5.39%, mom). The oil companies had announced a petrol price hike of Rs 2.50 a litre on 15 January 2011 seeingconsiderable upside on global crude oil prices. The spot prices of crude are currently seen hovering in the range of USD 85-90 a barrel. The crude prices have not hardened much since the sharp upside seen in November. As a result, the domestic oil companies have gone ahead on record to state that they do not foresee another round of petrol price hike in the near term. Moreover, the government too remains reluctant in revising the prices of diesel upwards, despite oil companies facing huge losses on a daily basis. In light of above factors, we see stability on domestic fuel prices arresting upward movements on the Fuel index.But in current context, it is the rise in manufactured products inflation, which is of greater concerns as it tends to be sticky in nature. The manufactured products index has presently risen by 0.8% (mom) in Jan 11, which is double the 0.4% (mom) increase seen previous month. The current upside on manufactured products index is also the fastest since April 10. Even the RBI's preferred indicator, the non-food manufactured products index, has moved up by 0.7% (mom), sharply up from an average uptick of 0.2% seen over the past few months. This sudden and considerable increase in manufactured products inflation is also reflected in the prices data of PMI manufacturing index. The PMI data releases for months of December 2010 and January 2011 have seen the input & output prices indices move up at a very sharp pace. The manufacturers had previuosly felt the stress, in terms of rising input costs and slow recovery in demand. However, with a significant rise in demand side pressures coupled with current high capacity utilization levels, the manufacturers are now in a position to set the output prices upwards. Such increase in the pricing power with manufacturers is alarming, especially in a scenario where the input costs are primarily on the upside. Therefore over the next couple of months, despite visible softening in food prices and possibility of stable fuel prices domestically, we continue to see considerable pressure on headline inflation coming from the manufactured products.
In light of above developments, we do not see the fiscal year end inflation reading matching the RBI's projection of 7%. Even going by conservative estimates, we see the fiscal year end inflation reading crossing 8% levels. Taking these possibilities into consideration, we see the RBI hiking rates by 25bps at its mid-quarter review scheduled in March 2011. However, if the developments on the inflation front turn out to be much worse, expectations may rise for the RBI to adopt a more aggressive stance.


Source: IDBI Gilts