Falling food, fuel prices pull down inflation

Wholesale Price Index (WPI)-based inflation fell to the lowest level in almost five years to 1.8 per cent in October, due to a broad-based decline in all sub-indices. The sharp fall was witnessed in inflation of food and fuel , the latter due to tumbling global oil prices.

Crude oil prices for the Indian basket ended October at $83.8 a barrel (bbl) as compared to $95.3 a bbl at the beginning of the month.

In the first half of November, global crude prices fell further. However, the impact on inflation might be contained, as it was offset by the recent increase in excise duty on petrol and diesel by Rs 1.50 a litre. With oil retailers asked to absorb the tax increase, a reduction in retail prices is unlikely. As of November 13, crude oil prices for the Indian basket were at $77.19 per bbl.

Primary food inflation fell by 0.7 percentage points (ppt) to 1.4 per cent in October due to a fall in prices of vegetables (-4.6 ppt), cereals and pulses (-0.6 ppt), and egg, meat and fish.

Fuel inflation also declined by almost 0.9 ppt to 0.4 per cent in October as petrol prices fell and electricity prices rose at a slower pace. Petrol prices were reduced in October. The deregulation of diesel prices resulted in lower domestic prices in the month.

Core inflation, an indicator of demand-side pressure on prices, also stepped down in the month. Non-food manufacturing inflation, the Reserve Bank of India (RBI)'s measure of core inflation, fell to 2.5 per cent in October from 2.8 per cent in September. Inflation in textiles, leather, rubber and plastic products, basic metals and transport and equipment saw the biggest fall in the month.

The CRISIL Core Inflation Indicator (CCII), an alternative measure of core inflation which is calculated by removing metal prices from the prices of manufactured articles, stood at 2.6 per cent in October, a tad higher than the RBI's measure of core inflation. The reason that metals are excluded from the CCII is that metal prices are mostly determined by changing global demand-supply dynamics and volatility in exchange rate rather than domestic conditions alone. Even in October, basic metals inflation fell to 1.1 per cent in October from 1.3 per cent in September, with ferrous metals inflation easing to 1.4 per cent from 1.7 per cent previously. As the downward pressure from metals is not captured in CCII, core inflation as measured by CII was higher than that measured by the non-food manufacturing index.

Moreover, unlike in the RBI's measure of core inflation, CCII includes manufactured or processed food prices, as these reflect second-round impact of inflation in primary food articles, and therefore capture domestic demand-side pressures in the economy. As inflation in primary food articles fell sharply and demand continues to remain fragile, manufacturers of food articles seem to have passed on falling costs to consumers. Consequently, manufactured food inflation fell to 2.1 per cent from 3 per cent in September. This resulted in a decline in CCII.

Going ahead, downward pressures on inflation are likely to continue till the calendar year-end as food inflation trends lower, as risks from the monsoon have abated and a strong base effect from last year keeps annual inflation low. However, as the economy picks up momentum, the recent downward trend in the core inflation is likely to be capped.

Despite the recent sharp fall in inflation, we do not expect a repo rate cut in the remaining part of the financial year, as the RBI would wait till there are clear indications that the fall in inflation will be sustained, before beginning to lower the repo rate.