CPI inflation back in target range

After eight months above the Reserve Bank of India (RBI’s) target band of 2-6%, Consumer Price Index (CPI) inflation was finally back in range, declining for the second straight month to a below-consensus 4.6% in December, from 6.9% in November. Average CPI inflation during April-December now measures 6.6%, down from the April-November average of 6.9%.

Not only did CPI inflation fall on-month, aided by a massive decline in food prices, but the high base effect of last year also helped pull down headline inflation. But while core inflation softened marginally, fuel inflation went up in December.

Food inflation, with 39.05% weight, softened substantially to hit a 16-month low of 3.5% in December, from 9.5% in November. Most of the decline in food inflation was due to a slump in vegetable inflation to -10.4%, from 15.5% in November, driven by a broad-based decline in vegetable prices, especially that of staples like onions, potatoes and tomatoes, partly reflecting the success of government initiatives like timely imports.

However, price pressure in other high food inflation categories like proteins declined only marginally. Animal proteins, for instance, continued to witness double digit inflation, with meat and fish inflation at 15.2% (compared with 17% in November), and eggs inflation at 16.1% (20.4% in November). Pulses inflation clocked 16.0% in December, compared with 18.1% in November. On the other hand, oil and fats inflation rose to 20.0% from 17.9%, in line with rising international oil prices. Fruit inflation also rose to 2.7%, from 0.2%.

Core inflation, i.e., headline sans food and beverages, and fuel and light, softened only marginally at 5.6%, just 15 basis points (bps) lower than November, suggesting continuing stickiness in core inflation. This could be reflective of mild improvement in demand conditions on one hand and rising input prices on the other. Core inflation has a weight of 47.3%, and is a sizeable contributor to headline inflation.

Clothing and footwear inflation rose to 3.5% in December, from 3.4% in November. Another category that saw upward inflation price pressure was recreation and amusement that rose to 5.2% from 4.5%. Health inflation also rose to 6.0% from 5.6%. That said, inflation softened in idiosyncratic categories, i.e. personal care and effects (to 11.7% from 12.0%) and transport and communication (to 9.3% from 11.1%).

With rising international commodity prices and an improvement in domestic industrial activity, fuel inflation reversed its declining trend to rise to 4.7% in December from 3.3% in November. Within that, fuel and light inflation rose to 3.0% from 1.6%, and petrol and diesel inflation to 11.4% from 10.0%.

With inflation back in the target range of 2-6%, December has offered the RBI some much-needed respite. However, the RBI will still need to be watchful of the inflation trajectory going ahead with global commodity prices on the rise and the favourable base effect starting to taper off from January 2021

This suggest that it may be a while before inflation firmly reverts to the RBI’s medium-term inflation target of 4.0%. Rate cuts will have to wait till then, while the upcoming budget will also have a bearing on the MPC’s upcoming monetary policy decisions.

For fiscal 2021, CRISIL projects CPI inflation at 6.4%.