CPI inches closer to 5% mostly led by fuel

Consumer price index (CPI)-based inflation marched higher to 4.9% in May from 4.6% in April. Fuel was the main driver of overall inflation in May, jumping up over 100 basis points (bps), while core inflation, which had added to the central bank’s woes last month, crept 20 bps north, nearly touching 6%. The pick-up was also led by food inflation, which rose 30 bps after having declined for 4 months in a row.

The pick-up in fuel inflation was inevitable with global crude oil prices rising 7% on-month and over 50% on-year in May. Meanwhile, the other shock to imported inflation also came from the fall in rupee, which fell on 3% on-month against the dollar during the month.

The discomforting aspect is the sustained increase in core inflation categories since March, which suggests manufacturers are perhaps taking advantage of improving demand conditions and passing on higher input costs (from oil, rupee and metals) to consumers.

Even after excluding the impact of house rent allowance revisions on housing inflation, core inflation was up 20 bps in May. It is this sustained increase in core inflation that led the Monetary Policy Committee (MPC) to raise the policy repo rate by 25 bps to 6.25% in its June 6 policy meet - the first hike in over four years. The MPC was also worried about core inflation rate staying higher than the committee’s inflation rate target of 4%.

Going forward, inflationary conditions are likely to firm up. With improving domestic demand conditions, manufacturers will pass on higher input costs to consumers, which will show up in core inflation. On an upward trajectory, crude prices were nearly 18.6% higher on-year in fiscal 2018. CRISIL expects another 23% average increase in average crude oil prices this fiscal. Also, metal prices are also firming up.

Similarly, food inflation will have a softening bias this year, it may stay relatively low given the expectation of a normal monsoon. However, aggressive implementation of the announced minimum support price measures could offset the impact of good monsoons numbers.

For fiscal 2019, therefore, CRISIL expects CPI inflation to perk up to 4.6% from 3.6% a year before. We believe there is a possibility of another rate hike if crude oil prices stay at current levels. While monetary policy will stay vigilant, further policy rate action will most likely only be effected if the rise is perceived as being sustainable, with pressures suggesting seepage into generalised inflation through stronger domestic demand.