Inflation elevates further

Hello subscribers,

Wishing everyone a happy Diwali and prosperous New Year. Thank you for reading Dispatch yet again. For this week it’s one of the most affecting topics, though it is not exactly a part of finance - “Inflation” .

Headline inflation (measure of the total inflation within an economy, including commodities such as food and energy prices, which tend to be much more volatile and prone to inflationary spikes) for October rose to a high of 7.61% YoY (higher than our expectation) primarily driven by food inflation, while core inflation (change in the costs of goods and services but does not include those from the food and energy sectors. This measure of inflation excludes these items because their prices are much more volatile) also rose sequentially.

Core inflation again rose on back of a rise in recreation group and housing index (could be a one-off given these sectors are opening up) while sequential contraction was seen in the personal care group and transport aided by lower gold and oil prices. Overall core group could see volatility dependent on oil and gold trajectory and some revival in demand.

This leads our expectations of H2 averaging above 6% YoY, higher than the MPC’s (Monetary Policy Committee of India) forecast of averaging around 5%. Industrial production entered positive territory in September after contracting for six months on the back of festive demand uptick, especially for consumer goods. 

IIP (Index for Industrial production) for the next few months might point towards recovery owing to festive and pent-up demand guiding the production. However, the sustainability of recovery needs to be watched beyond the festive months to gauge the return of consumer appetite.

Key takeaways:

Food inflation rose substantially to 11.07 % YoY vs. 10.68 % last month. Overall the food inflation moderation in vegetables is encouraging and would have to be monitored and sequential contraction in food grains is on expected lines. The protein group is often in tandem with global prices, and given the rise in global food prices could be adding to the upside which is worrying and would need to be monitored.

Miscellaneous services inflation was nearly flat at 6.88% YoY vs. 6.89% YoY last month, with sequential increase of 20 bps, lower than last month’s sequential increase of 27 bps. The key driver in miscellaneous services was recreation and amusement which saw a rise of 123 bps in October as compared to a decline of 7 bps last month mostly due to festive season and opening of economies. Sequential momentum in transport and communication contracted by 14 bps vs. a rise of 72 bps last month while personal care has also seen a contraction by 6 bps vs. decline of 88 bps in last month, while other components within services showed marginal to no increase in sequential momentum.

Core inflation rose to 5.77% YoY from 5.67% YoY last month. This was essentially driven by a rise in the recreation a group (in misc. services) and marginal rise in housing index by 96 bps on a sequential basis which could be a one-off due but would have to be monitored given these sectors are opening up. The sequential momentum-contraction seen in transport and personal care group is on expected lines given the recent decline in oil and gold prices. Going forward, overall core group could see volatility on account of oil and gold prices and some revival in demand seen in latest high frequency data. 

Minutes from the last policy showcased intent of the newly formed MPC (Monetary Policy Committee of India) members to address elevated term-premia (bonuses that investors traditionally received for the added risk of owning longer-term bonds). This has been followed by action seen through increased allocation toward OMO (open market operations) purchases. We expect this trend to continue, which could cushion the impact of the large supply of government paper.  For H2 we expect ~INR 2.5 tn of OMO purchases both in G-Sec and SDLs (State development loans), which is expected to aid sentiment in the fixed income markets. 

We will remain watchful of emerging risks from 1) the global environment assisted by possible success of the vaccine and a Biden victory which could add upside to global bond yields with a ripple effect on domestic markets 2) incrementally positive data on growth.  While we do not think that would lead to any change in stance by the MPC, markets would watch out for signals from the RBI/MPC on growth outlook which could have a bearing on reversal of the widening of the LAF (Liquidity Adjustment Facility) corridor in the foreseeable future.

Thank you for taking the time out to check Dispatch. I hope it was worth it.

Best wishes from Dispatch for Diwali.