Expert Opinion

Published: Dec 29, 2021
Updated: Dec 29, 2021

Retail Inflation: Crude prices stoking inflation

The pace of headline inflation (CPI) eased to a three-month low in July 2021 at 5.59% against 6.26% in June 2021, bringing it back within the RBI’s tolerance band of 2-6%. The provisional number for retail inflation is in line with CARE Ratings’ projection of 5.5%. The easing of supply chain disruptions and improved mobility have led to the moderation in retail prices. However, one should note that the CPI print for the current month is over a fairly high base of 6.73% in July 2020, which points towards the strengthening of inflationary pressures in the economy. The core CPI, which excludes food and energy prices, has slightly edged down to 5.95% against 6.17% a month ago and 5.7% the year before, indicating pressure build-up in the economy. On a regional level, urban areas witnessed a higher increase in price levels as compared to rural areas.

Component-wise inflation analysis

• Food & Beverages inflation, which has the highest weight of 45.86% in the CPI, moderated to 4.46% in July 2021 over a fairly high level of 8.5% in July 2020. On a monthly basis, there was a slight moderation from 5.58% in June 2021. This growth in food prices was driven by a sequential price rise in items like eggs and milk. Vegetable prices witnessed a year on-year contraction of 7.75% in July 2021 over the 11.1% growth in July 2020.
  — Edible oil inflation has marginally moderated to 32.53% from a month ago (34.78% in June 2021). Edible oil prices touched record highs in the overseas markets amid lower supplies in the main producing and exporting regions. This has pushed up prices of the commodity in the domestic markets, given the reliance on imports. The increase in edible oil prices remains a worry as it is mostly a reflection of the international prices.
  — The price rise in pulses by 9% (over the 15.7% growth in July 2020) is driven by supply shortages in:
  a) the producing regions (domestic and overseas) due to adverse weather conditions (drought), and
  b) by rising demand. Supply bottlenecks have added to the price pressures. However, government intervention in maintaining buffer stocks can cool price of pulses in the coming months.
• Fuel and light inflation declined marginally to 12.4% in July 2021 over the 12.7% growth in June 2021. This is still much higher compared to the growth of 2.7% in July 2020. The consistent rise in global crude oil prices, coupled with the high domestic taxes, has been pushing fuel prices upwards and could lead to costpush inflation in the coming months.
• Price levels for the miscellaneous component grew by 6.7% in July 2021 over the growth 6.8% in July 2020. Sequentially, there has been a decline from the growth of 7.3% in June 2021. Although the services sector is witnessing demand recovery across segments, the declining trend suggests that the impact of the second Covid wave is still there. The higher base effect during the corresponding months in FY21 also has a role to play.

Core CPI

The year-on-year growth in core inflation eased marginally to 5.95% in July compared with 6.17% in June. This growth is against the high base of 5.27% in July 2020. Given that core inflation includes the non-volatile components of the CPI, the elevated levels of core inflation point towards the underlying prices pressures prevailing in the economy. Core inflation has been over 5.5% for the last seven months (since November 2020). However, since May 2021 a declining trend is witnessed mainly on account of declining growth in services prices under the miscellaneous category.

State-wise inflation

Exhibit 3 presents a state-wise comparison of retail inflation (on a year-on-year basis) for 21 Indian states: — Ten states have recorded inflation more than the allIndia retail inflation for the month (5.59%). — Amongst the states, Himachal Pradesh saw the highest retail inflation at 7.9%, followed by Telangana at 7.7%. — Retail inflation has crossed the mark of 6% in 7 out of 21 states. — Inflation was amongst the lowest in the case of Assam (at 2%) and Odisha (4%).

CARE Ratings’ view

In the recent credit policy announcement, the RBI has revised the inflation outlook for FY22 upwards by 60 basis points. This higher projection is despite the central bank’s firm stance on inflationary pressures being transitory due to supply side bottlenecks. In the coming months, easing of movement restrictions will provide some relief to the supply chain disruptions. However, elevated global crude oil prices could strengthen the underlying core pressures.

Prices in the services sector will also see a rising trend because of improved mobility and increased vaccination momentum. Food prices are expected to soften provided there are no further delays in sowing due to an erratic monsoon. With this background, we expect the CPI numbers in the next two months to remain close to the upper band of the RBI’s target range, around 5.5-6%, despite the high statistical base.