Headline inflation still in negative zone, but fuel price rise limits overall decline

The Wholesale Price Index (WPI)-based inflation continued to fall in May, dropping to -2.4 per cent from -2.7 per cent in April. But some upside pressures from fuel prices limited the decline in overall inflation this month as petrol and diesel prices were raised. During May, a combination of higher global oil prices (16 per cent higher than March '15 levels) and weaker rupee (eight per cent year-on-year) put pressure on fuel imports and pushed up domestic fuel prices.

Still, the headline inflation number has declined for the seventh month. Much of the decline over these months stems from fuel inflation (-10.5 per cent y-o-y in May, but a lower decline compared to the past three-month average of -13.3 per cent).

Meanwhile, manufactured products' inflation declined for the third consecutive month (to -0.6 per cent against 0.5 per cent last month), indicating strong disinflationary trends. Food inflation (primary articles plus manufactured goods) continued to provide respite as it fell to 2.3 per cent in May from 3.5 per cent in April. However, a weak monsoon this year threatens to put pressure on food prices.

In May, non-food manufacturing inflation declined slightly to -0.6 per cent while the CRISIL Core Inflation Indicator (CCII) remained unchanged from the previous month, at a decadal low of -0.1 per cent. With economic recovery remaining fragile, demand-side pressures on inflation have stayed benign, as hinted by the core indicators.

This month, higher fuel inflation was the reason behind some kick-up in the WPI and Consumer Price Index-based inflation, while food inflation continued to head southwards. Oil prices have since then declined - average of $63.2 a barrel in June - while the rupee has stabilised at 63.9 versus the dollar, which is the same value as in May. This suggests that domestic fuel prices might not rise much further. For FY16, we expect oil prices to average at $60-65 a barrel (Brent) in FY16 from an estimated $85 a barrel in FY15, while the rupee should stabilise at 63. Yet, there is reason for caution on the food inflation front, with some items like pulses recording significantly high inflation.

The decline in headline inflation was capped by higher fuel inflation (at -10.5 per cent in May against -13 per cent in April) due to higher prices of furnace oil (12 per cent), petrol (8 per cent) and high-speed diesel (4 per cent). The month also saw price increases in bitumen and electricity.

In primary articles, inflation in food articles fell sharply to 3.8 per cent in May from 5.7 per cent in April, mainly due to a drop in fruit and vegetables' inflation (to 2.2 per cent from 7.4 per cent). This offset the pick-up in pulses inflation (22.8 per cent from 15.4 per cent). The rise in pulses inflation is a concern, given the monsoon threat. Already, pulses production in FY15 was estimated to be 11 per cent below target, sowing is 8.7 per cent lower than last year, and global prices have been hardening, implying imports might not provide much respite to prices.

Core inflation continued to exhibit disinflationary trends. Non-food manufacturing inflation further declined to -0.6 per cent led by falling inflation in textiles (-2.7 per cent) and basic metals (-3.1 per cent), while other items continued to post negative inflation - such as leather and products, rubber and plastic products, and chemical and products.

CRISL Core Inflation Indicator (CCII) - an alternative measure of core inflation calculated by removing basic metal prices from the prices of manufactured articles - stayed unchanged from the previous month at -0.1 per cent in May. Metals are excluded from the CCII as its prices are mostly determined by changing global demand-supply dynamics and volatility in exchange rate, rather than domestic conditions alone. This exclusion caused a variance in the CCII and the non-food manufacturing inflation during May. In the basic metals category, the fall in inflation steepened to -3.1 per cent in May from -2.7 per cent in April as inflation in ferrous metals fell to -4.6 per cent (from -3.6 per cent in April).