Weakness in domestic demand

CRISIL's Core inflation Indicator (CCII), a measure of demand-side pressure on prices, rose to 2.7 per cent in September from 2.6 per cent in August. However, it remains significantly lower than 6.5 per cent a year ago. The decline in CCII in recent months reflects sustained weakness in domestic demand. Industrial output grew by a mere 0.1 per cent in April-August, against a year ago. This was despite a low base of 0.2 per cent Index of Industrial Production (IIP) growth during April to August last year. Trade data for the first half of 2013-14 showed imports, excluding oil and gold, falling by around five per cent on a y-o-y basis, reflecting slowing demand for consumption and capital goods.

In September, higher inflation was observed in certain manufactured items such as chemicals, machine tools, leather and rubber and plastic. However, the impact of higher inflation in these non-food manufactured categories was offset by a continued decline in price rise of manufactured food, which fell to 31-month low of 1.6 per cent in September. For the remaining part of this financial year, manufactured food inflation is expected to stay low, pulling down CCII, due to a high base from last year and weak domestic demand.

In September, CCII continued to remain above non-food manufacturing inflation, the Reserve Bank of India (RBI)'s measure of core inflation. Non-food manufacturing inflation was 2.1 per cent in September, which tends to underestimate demand-side pressures as it includes metals prices, which have been falling since April 2013. In September, ferrous and non-ferrous metal prices were 1.9 per cent lower than a year ago. Given metal prices are largely influenced by changing global demand and volatility in exchange rate, rather than domestic demand pressures alone, metals must be excluded while measuring core inflation, as is done in the CCII.

Though low core inflation continues to reflect weak demand pressures in the economy, overall wholesale inflation surged to 6.5 per cent in September due to 18.4 per cent inflation in primary food articles (prices of vegetables soared nearly 90 per cent against last year) and the continued increase in diesel prices. With inflation rising, we expect RBI to raise repo rate further in its monetary policy review on October 29.