Consumer Price Index (CPI)-linked inflation surged with the onset of the pandemic and resultant lockdown in March 2020. This was surprising, and in contrast to the experience of most other major economies, where the gauge fell because of massive demand destruction. As the economy braces for the second wave and renewed restrictions, inflation will be a crucial determinant of India's efforts to recover economically, and food prices, the driver of inflation trajectory.
Our analysis of quarterly movement in headline CPI inflation, suggests food & beverages has the maximum correlation or a linear relationship with headline inflation, followed by core and fuel & light inflation. Food has historically punched more than its weight in headline inflation, despite a lower weight compared with core. Not only does food inflation guide headline inflation the most, but also is the most volatile. Its standard deviation (a measure of volatility) for the analysis period was more than double that in core, the most stable category. Of the 12 major sub-categories of the Indian CPI food basket, vegetables, cereals & products, and milk & products have generally been relatively large contributors to overall food & beverage inflation. And within these, vegetables have dominated. The role of the other two has, in fact, diminished over the years.
Poor monsoons have statistically not been be associated with high food inflation. Comparison of annual rainfall and food inflation trends since fiscal 1991, revealed aweak relationship between both, which is not entirely surprising, given that a) our CPI food basket includes categories that are not directly dependent on monsoon, and b) temporal and spatial distribution of rainfall matters more than the all-India average rainfall.
A key concern on the inflation front since the past few months has been the sharp rise in international commodity prices. We found a reasonable degree of positiverelationship between international commodity prices and Wholesale Price Index (WPI)- linked manufacturing inflation. But the relationship with CPI core inflation is not only weak but also negative.
CRISIL estimates CPI inflation will soften this fiscal. This is premised on food inflation, the key driver of headline inflation, falling this fiscal because of a high base effect, and forecast of a normal monsoon, suggesting healthy agriculture output, which should keep a tab on food prices. That said, vegetable inflation will remain a key monitorable and can create wild swings in food inflation. Pandemic-related supply/logistics disruptions too have an upside risk to food inflation. The rise in real gross domestic product (GDP) growth this fiscal, statistically doesn't pose a risk to core inflation. Moreover, growth this fiscal is largely optical in nature, on the low base of previous fiscal. International commodity prices, barring crude oil, too do not pose an incipient risk to retail core inflation. That said, stickiness in core can persist as demand conditions improve compared with fiscal 2021. In sum, core inflation is expected to remain sticky going ahead, but is unlikely to shoot up rise significantly.
