India preview: Inflation to surprise Reserve Bank with another slowdown

India’s inflation likely slowed sharply in February, diverging further from the central bank’s projected pickup. Bloomberg Economics estimates the consumer price index rose 4.54% year on year, down from a 5.07% rise in January. Seasonal disturbances and one-off factors that drove inflation upward in 2H 2017 are now reversing. A second month of cooling consumer prices should act to counter the Reserve Bank of India’s hawkish bias, staying its hand in April. The data are due on March 12.

Key points:

* Bloomberg Economics’ expectations for slowing inflation run counter to projections of the central bank. The RBI forecasts inflation will average 5.1% in 4Q fiscal 2018 (which ends in March) and pick up to a range of 5.1%-5.6% in 1H fiscal 2019. 

* Prices of onions and tomatoes (0.6% weight each in the CPI basket) cooled further as a late summer crop reached markets. Retail prices of onions were up 140% year on year in February, slowing from 188% in January, according to daily food price data from the consumer affairs department. Tomato prices were up 20%, slowing from 56%. A larger harvest from the winter crop is expected by end-March and in April, and this is likely to further cool vegetable price inflation.

* The inflationary impact of rent allowances hikes for government employees likely peaked in February and will start fading out of year-on-year comparisons. 

* The combined effect should be to push inflation back to around the 4% level over the next two months.

* We expect the RBI to cut rates at its June policy review as inflation surprises to the downside. That said, we recognize that the monetary policy committee’s hawkishness at its February meeting raises the bar for further easing.
 
Inflation Slowdown to Build Case for RBI Rate Cut
 
In the details:

Food prices, as measured by the Department of Consumer Affairs’ daily food price data (which track about 50% of the food categories), registered a month-on-month drop of 1.3% in February relative to a 0.3% decline in the same month a year earlier. On a year-on-year basis and taken together with the National Horticulture Board’s figures on fruits and vegetables, this is expected to lower food inflation to 3.6% in February from 4.6% in January.

Core-CPI inflation excluding housing is expected to remain benign around the 4% level. This reflects the economy’s wide output gap and downward revisions to GST tax rates. The disinflationary impact of the GST revisions should accelerate as new tax compliant inventory hits retail store shelves.

Inflation in the other categories is expected to stay flat in February. Marginally higher year-on-year domestic gasoline inflation will exert upward pressure, but it is likely to be countered by lower indirect tax rates on multiple goods and services since mid-November.

CPI Inflation Likely Eased to 4.5% in February

Within the food component of the CPI, the largest disinflationary effect is from a monthly correction in onion and tomato prices, which dropped 18% each in February. Falling sugar prices also likely helped contain food inflation. While year-on- year inflation in pulses likely picked up on base effects, a monthly drop in prices owing to another good year of harvest is limiting the inflationary impact.

 
Vegetables Lead the Drop in Food Inflation

Risks to our CPI forecast:

The main risk is uncertainty over the impact of the reduction in GST tax rates over the past few months. We assume it will have a 0.05 ppt disinflationary impact on headline inflation in February, as many consumer goods companies have said that they are in the process of passing on the benefit of tax cuts.

There is no one-to-one relationship between month-on-month inflation predicted by the daily food price data and CPI food inflation. Daily food price data used to forecast the CPI food component is based on only 22 of the 127 food items in the CPI basket. The author is India Economist, Bloomberg LP