Starting FY16 on a disinflationary note

The fall in the wholesale price index (WPI) steepened in April "dropping to -2.7 per cent from -2.3 per cent in March. This is the sixth consecutive decline in WPI inflation, signaling mounting disinflationary pressures in the economy. A major part of this has come from a decline in fuel and power inflation " averaged at -10.6 per cent since November 2014. In April, along with fuel inflation, primary article (-0.5 per cent) and manufacturing inflation (-0.5 per cent) also turned into the negative category. However, as fuel prices start to firm up from their lows in the last quarter, fuel inflation might see a moderate uptick in the coming months.

Measures of core inflation, "the non-food manufacturing inflation was negative at -0.4 per cent and the CRISIL Core inflation Indicator (CCII) also fell to a decade low of -0.1 per cent in the month. As the economic recovery continues to remain fragile, demand side pressures remain benign on inflation as indicated by the core indicators.

Lower readings for both WPI and CPI this month, along with weak IIP data, opens up room for the RBI to reduce the policy rate further. We expect RBI to reduce the repo rate by 25bps on June 2 " the next monetary policy meeting. An out of policy rate cut in the next few days cannot be ruled out.

Headline inflation was pulled down by falling fuel price and power prices (inflation fell to -13.0 per cent). Prices remained unchanged in coal while dropping sharply in mineral oils (-19.1 per cent). The latter was influenced by low prices of LPG (-6.1 per cent), Petrol (-18.4 per cent) and High speed diesel (-14.4 per cent). Crude oil prices have firmed up in recent months however we believe this uptick will be temporary. We expect oil prices to average at $60-65/barrel (Brent) in 2015-16 from an estimated average of $85/barrel in 2014-15.

Turning to primary articles, food inflation softened to 5.7 per cent from 6.3 per cent in March as a drop in fruits and vegetable inflation (7.4 per cent from 11.3 per cent in march) offset the pickup in food grain inflation (+80 bps). Despite this it was worrying to see that inflation in pulses shot up to 15.4% in April, signalling that the impact of unseasonal rains is filtering through. This trend was missing in the CPI data released on May 12 and is likely to raise food grain inflation in May.

Core inflation, " an indicator of demand-side pressure on prices, " continued its downward journey in April. Non-food manufacturing inflation remained negative at -0.4 per cent with the following items recording negative inflation " textiles (-2.0 per cent), basic metals (-2.7 per cent), chemicals (-1.6 per cent), rubber (-1.3 per cent) and leather (-2.1 per cent). In other categories such as paper & paper products, and machinery and machine tools inflation moderated in the month.

CRISL Core inflation Indicator (CCII), " an alternative measure of core inflation which is calculated by removing metal prices from the prices of manufactured articles" turned negative to -0.1 per cent from 0.4 per cent in March. 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. In April, overall basic metals prices was negative (-2.7 per cent) with inflation in non- ferrous metals declining (0.4 per cent) while being negative for ferrous metals (-3.6 per cent). As a result, CCII and the non-food manufacturing inflation were at variance. Some of this gap was filled with falling manufactured food inflation, " an item included in the CCII. Manufactured food inflation turned negative to -1.0 per cent from 0.6 per cent previously. This came on the back of declining sugar and tea and coffee prices. The decline in sugar prices is in line with the fall witnessed in global sugar prices in recent months.