CPI & WPI Inflation Numbers Surprise Everyone

The Ministry of Statistics and Programme Implementation (MOSPI) announced the CPI and the WPI numbers for the month of February. Both the numbers were expected to come out on the higher side due to the weakening of the base effect as well as rise in oil prices, which tends to have a sharper impact on the WPI. A sharply higher CPI, which went up from 3.17% in January 2017 to 3.65% in February 2017, virtually rules out any prospects of a rate cut by the RBI in its April monetary policy. Of course, the CPI inflation is still within the RBI comfort level of 4%, but then the MPC may prefer to wait out for a couple of months as it has been consistently worried about the stickiness of non-core inflation. That has been evident in the evaluation of the minutes of the MPC on the last 2 occasions.

Food inflation makes a comeback in the CPI…

It was food inflation that had consistently driven the overall inflation down in the last few months. A normal monsoon and a record Kharif output in 2016 meant that food prices were largely tamed. The overall food inflation has gone up sharply from 0.61% in January 2017 to 2.01% in February 2017. In fact, urban food inflation saw a sharp turnaround from negative inflation to positive inflation at 1.87%. In the month of January we had seen a sharp deceleration in food prices across vegetables and pulses. In both the cases, there were fire-sales which actually tended to artificially dampen the food prices accentuating the fall in inflation. For February, fruits have showed high positive inflation even as pulses and vegetables continue to remain in negative territory.

Pulses and vegetables continued to drag the CPI inflation down…

A quick reading of the CPI components underlines that the real downward pressure came from pulses and vegetables. Vegetables deflated at (-8.29%) while pulses deflated at (-9.02%) for the month of February. In fact, one of the worries for policy makers is that if these two anomalies get rectified then the actual food inflation may settle at a much higher level. Fruits showed positive inflation at 8.33% while cereals inflated by 5.3%. The biggest contributor to food inflation was sugar which was up by 18.83% on a YOY basis. Milk also inflated at 4.22% in February and with key milk producers looking to hike milk prices one can expect the milk inflation to go much higher from these levels. The crux of the matter is that the low food inflation is largely due to deflation in the prices of pulses and vegetables; both of which are unlikely to sustain in the coming months.

How the WPI inflation panned out in February…

For the month of February 2017, the WPI inflation was sharply higher at 6.55% compared to 5.25% in the month of January 2017. Interestingly, the IIP was in negative territory for over 18 months from the time the price of crude started to fall in the month of November 2014. At the peak of the divergence, the WPI inflation was quoting at a 900 basis point discount to the CPI inflation. From there, the WPI inflation has moved up sharply to a premium of 290 basis points over the CPI inflation. However, with the OPEC supply agreement already in trouble the oil prices have already started falling globally. In fact, the price of Brent Crude in the international markets has already dropped from $56/bbl to $48/bbl on the back of higher US production, rising stockpiles and apprehensions that the OPEC supply agreement may not sustain after its 6-months validity.

Breaking up the WPI Inflation into key components…

Unlike the CPI inflation that gives a high weightage to food items, the WPI inflation tends to be vulnerable to rising oil prices globally. More so, in the Indian context where nearly 80% of the daily oil requirements continue to be imported! Even though fuel & power has a weightage of just 15% in the overall WPI inflation, the sharp rise in the price of coking coal and aviation turbine fuel spurred the WPI higher. Primary articles overall have a weight of 20% in the WPI. Within the primary articles, food articles were almost flat. While non-food contributed in a small way, it was minerals like manganese ore, copper ore, iron ore and crude petroleum that were up by nearly 9% and contributed significantly to pushing the WPI inflation higher. Manufacturing, which constitutes 65% of WPI inflation, was flat and hence the major push to the WPI inflation came from minerals and fuel prices. With the OPEC supply agreement facing an uncertain future there is hope that lower oil prices may push WPI inflation lower in the coming months.

Where does it leave the outlook for RBI rate stance?

The Monetary Policy Committee (MPC) in its February minutes had clearly indicated a shift in monetary stance from accommodative to neutral. The demonetization has ensured that the transmission of lower rates has been achieved to the fullest extent possible. From a CPI perspective, the RBI may still prefer to await inflation data for a few more months to gauge if there are further upside risks to retail inflation. WPI inflation may temper in the coming months with fuel prices moving lower. The IIP has shown signs of a pick-up post remonetization and that should hold the economy in good stead. As long as the Fed stance stays hawkish, the RBI may not really have an incentive to cut rates even if inflation tempers. That is something the financial markets need to be prepared for!