India’s inflation shocks and surprises

All told, we think the RBI will embark on a gradual normalisation path from 4Q2021.

By Pranjul Bhandari & Aayushi Chaudhary

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CPI and WPI inflation for May shocked and surprised for three reasons.
CPI soared, breaching the RBI’s upper tolerance threshold
CPI inflation came in much higher than expected (actual: 6.3% y-o-y, HSBC: 5.5%, consensus: 5.4%). Note that this is higher than RBI’s upper tolerance limit of 6%. Core inflation was the main source of upside surprise, coming in at 6.5% vs 4.8% in April.

And within the core basket, price pressures were across the board—personal care, health, household items, recreation, clothing and education. Fuel inflation was elevated, but as expected in the face of higher global oil prices. Food inflation rose higher, led by oils, spices, vegetables and fruits, and to a smaller extent, pulses and cereals. However, the food uptick was broadly in line with expectations.

CPI momentum outpaces WPI
The last few months had been marked by WPI inflation rising faster than CPI inflation, as higher commodity prices raised cost of production and corporates did not pass on all increases to consumers. Indeed, corporate margins have been under pressure.

Tables turned in the May reading, with CPI sequential momentum outpacing WPI momentum across all key categories—food, fuel and core. This could be due to three reasons. One, producers are passing on more of the cost pressures to consumers. While this could be true on the margin, it may not be the full story. At a time when demand is uncertain, corporates may not be confident about passing on all price increases. Two, logistical disruptions are raising intermediate costs. This could be playing an important role, in face of the uncertainties created by local lockdowns.

However, this driver of higher CPI could fade away as local lockdowns are rolled back. Three, higher oil prices are raising transportation costs. This is playing an important role with higher global oil prices.

Rural inflation outpaced urban

Rural inflation outpaced urban inflation in food, fuel and core—in both annual and sequential terms.

At first glance, this looks odd. With the second Covid wave spreading quickly across the rural heartland, one would expect muted demand and price pressures emanating from rural India. But it is likely that trade, transport and other logistical disruptions are raising rural intermediate costs. It can be argued that urban India is able to deal with the new normal of the pandemic better than rural because the former went through these lockdowns last year while the latter was broadly exempted.

It is likely that as the second pandemic wave driven local lockdowns are rolled back, the sharp rise in CPI inflation will moderate. And yet, the May print is a reminder of how things can suddenly rise back up again in 2HFY22 when (1) high vaccination rates give a fillip to consumer demand and (2) rural Indians resurface from the second wave with higher demand for consumer durables like two-wheelers which make them feel safer in the face to repeated pandemic waves. All told, we think the RBI will embark on a gradual normalisation path from 4Q2021.

Edited excerpts from HSBC Global Research’s report dated June 14.

Respectively, chief India economist, & economist, HSBCSecurities and Capital
Markets (India) Private Limited