News Analysis

CPI inflation spikes, RBI to hit a long pause on rate cuts

Radhika Merwin BL Research Bureau | Updated on January 13, 2020 Published on January 14, 2020

Aside from sticky food prices, consistent rise in core inflation and crude prices, could well end the easing policy

Caught between the devil and the deep blue sea, the RBI may opt for a prolonged pause, with the CPI inflation reading for December way above its comfort zone. Led by sharp increase in vegetable and pulse prices, the December CPI inflation came in at 7.35 per cent (RBI’s inflation target is 4 per cent with a range of +/-2 per cent).

While the steep rise in vegetable inflation (60.5 per cent) may moderate in the coming months, the significant increase pulses prices could persist, keeping food inflation elevated.

Core inflation (excluding food and fuel) that had been moderating until now could also play truant, if the sudden spike in transport and communication — on the back of increase in railway and telecom tariffs — is any indication.

Above all, crude price increase has started to reflect on the CPI headline inflation. After five consequent months of negative growth (deflation), fuel inflation came at a positive 0.7 per cent. Further increase in crude prices will keep CPI inflation high in the coming months.

While growth concerns have only accentuated after the CSO’s sombre estimate for the current fiscal, the RBI may have very limited scope for further monetary policy easing.

Why the spike

CPI inflation shot up beyond 7 per cent levels, predominantly on the back of sharp rise in food inflation, which has a 45 per cent weightage in the CPI basket. After reporting 8.7 per cent increase in November, food inflation spiked to 12.2 per cent in December. This was in turn led by steep 60.5 per cent increase in vegetables prices and 15.4 per cent rise in pulses prices.

The sharp rise in food inflation has been very much on the cards, given the low base of last year. Between October 2018 and February 2019, food inflation was a negative 0.1 to 1.7 per cent, driven by sharp fall in vegetable and pulses prices.

But the intensity and pervasiveness of the increase is a concern. Aside from vegetables, cereals, eggs, milk, fruits, pulses and spices — all have seen a significant jump in prices in December. The stickiness in food inflation could hence persist for a long time, despite vegetable prices moderating in the coming months.

Also, both rural and urban food inflation is high, which is also worrisome.

Rising core inflation

The worsening slowdown had led to sharp fall in core inflation, led by health, personal care and household goods and services. From about 5 per cent levels in March 2019, core inflation had fallen sharply to 3.5 per cent in November.

But core inflation has inched up to 3.7 per cent in December on the back of spike in transport and communication inflation (to 4.8 per cent in December from 0.8 per cent in November). Increase in telecom and railway tariffs appears to be behind the sharp rise. A steady increase in core inflation will exert upward pressure on the CPI inflation.

Crude price has always been the joker in the pack. After five consecutive months of decline in prices, fuel inflation has moved into the positive territory signalling reversal in trend. The ongoing geopolitical tensions can lead to further rise in crude prices.

Hence overall CPI inflation may remain above 6 per cent levels in the coming months.

RBI woes

From the RBI’s perspective, the sharp rise in CPI inflation in December, pose several challenges. After the 135 bps cut in repo rate in 2019, there have been expectations of further rate cut, given the weak growth outlook. The CSO’s recent growth estimate for the fiscal (real GDP growth at 5 per cent) pegged at a 11-year low, is led by sharp fall in gross fixed capital formation and private consumption.

While there is a compelling case (on the growth front) for a rate cut in the February policy, elevated levels of inflation will impede rate actions in the near term. As such, the transmission of rate cuts so far has been weak.

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Published on January 14, 2020
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