Inflation momentum remains weak

Wholesale Price Index-based inflation (WPI) stood at 0.11 per cent in December, after recording zero per cent in the previous month. WPI inflation averaged 0.6 per cent in Q3 as compared to 3.9 per cent in Q2. On a month-on-month basis, WPI inflation dropped 0.9 per cent. Inflation stood at a standstill, as the rise in food inflation was offset by a sharp drop in fuel and power inflation in December.

Primary article inflation rose 2.2 per cent with food inflation rising by 5.2 per cent, while non-food inflation gone down three per cent. Vegetable prices saw a sharp decline of 4.78 per cent in December, while inflation in rice (4.4 per cent), pulses (5.8 per cent), fruits (17.8 per cent), and milk (9.7 per cent) continued to rise.

The sharpest fall was witnessed in prices of fuel articles due to the sharp fall in global oil prices. Prices contracted by 7.8 per cent in fuel and power. Inflation dropped most in petrol (-12 per cent), followed by diesel (-6 per cent) and cooking gas (-3 per cent). Crude oil prices for the Indian basket dropped close to $50/bbl in December-end as compared to $72/bbl. in November. We expect oil prices to remain benign in the coming months. We expect crude oil prices to reach $70-75/barrel (Brent) in 2015-16 from $85-90/barrel in 2014-15.

Prospects of lower oil prices over the medium term will also temper inflationary expectations. However, in the coming months, the impact of lower oil prices on inflation might be contained somewhat, as it is offset by the recent increases in excise duty on petrol by Rs 5.75 a litre and diesel by Rs 4.50 a litre by the government (announced in November, December and January).

Core inflation, an indicator of demand-side pressure on prices, also stepped down in the month. Non-food manufacturing inflation fell to 1.5 per cent in December from 2.2 per cent in November. Inflation in transport, equipment and parts reduced to zero per cent in the month as compared to 2.7 per cent witnessed at the starting of the fiscal in April. Inflation in basic metals also declined 0.18 per cent in December. In other categories such as paper and paper products, leather, chemicals, non-metallic minerals and machine and machine tools, inflation moderated in the month.

CRISIL Core Inflation Indicator (CCII), an alternative measure of core inflation calculated by removing metal prices from the prices of manufactured articles, fell to 1.8 per cent in December from 2.2 per cent in the previous month. The reason metals are excluded from the CCII is that metal prices are mostly determined by changing global demand-supply dynamics and volatility in exchange rates, rather than domestic conditions alone.

However, in December, overall basic metals inflation remained subdued (-0.2 per cent), with metal and ferrous metals, decline in inflation offsetting the rise in non-ferrous metals inflation (3.1 per cent). Therefore, CCII and the non-food manufacturing inflation were at similar levels. That said, CCII dropped by 0.4 ppt, while the decline in non-food manufacturing was larger at 0.7 ppt as compared to the November figures. This is because CCII includes manufactured or processed food prices, which rose to 1.7 per cent from 1.2 per cent in November. The slight increase in manufactured food products was led by a sharp jump in tea and coffee processing from 1.4 per cent to seven per cent, due to a weak statistical base effect from last year. In addition, inflation in other categories such as other food products and bakery products also edged up.

The recent decline in inflation, in comparison to the fall in 2009, is broad-based. The current dynamics of inflation show that measures of core inflation, the CCII and non-food manufacturing index are converging unlike in 2009. In addition, the fall in WPI is accompanied by a mirroring decline in the CPI index, something that was missing during 2009. This points towards the sustainability of the current inflation trend and makes a case for a cut in policy rates stronger. We expect the Reserve Bank of India to cut rates by April.