Inflation above comfort despite fall

by Manasi Swamy

Retail price inflation declined to 6.77 per cent in October 2022 from 7.41 per cent in September 2022. This is the first time when inflation has fallen below seven per cent in the last three months and only the second since the beginning of the current fiscal. While the fall was steep, it was not sufficient to put the concerns over high inflation to rest. This is firstly because despite the fall inflation continues to rule well above the upper limit of the Reserve Bank of India’s (RBI) tolerance band of 2-6 per cent. And secondly, the fall in headline inflation was limited to food and fuel. Core core inflation, which excludes food, fuel & light and petrol, diesel & other vehicle fuels, continued to advance further. Moreover, despite weakening of commodity prices, the core core inflation is not expected to ease much, at least in the short run. We discuss this in detail below.

Non-core core inflation, which comprises of food, fuel & light and petrol, diesel & other vehicle fuel prices, fell to 6.93 per cent in October 2022 from 8.47 per cent in September 2022. The fall in this too was largely concentrated in vegetable, edible oil and sugar & confectionary products. Inflation in the vegetables group slumped to 7.77 per cent in October 2022 from 18.2 per cent in September 2022. The fall was owed to the high base effect as vegetable prices increased in October from their month-ago levels. Similar was the case of sugar & confectionary group, which saw inflation alleviating to near zero level in October 2022 from 1.59 per cent in September 2022 without any sequential price fall. Inflation in edible oils fell in October 2022 on account of sequential softening of prices for the fifth consecutive month.

Prices of cereals and products continued to rise in October 2022 despite the government imposing restrictions on exports of wheat and rice. Inflation in the cereals & products group touched a 9-year high of 12.08 per cent in October 2022, rising from 11.53 per cent in September 2022. Inflation in milk & milk products at 7.69 per cent was also at its highest level since May 2020.

The milk group has seen fresh rounds of price hikes in November 2022 and a few more hikes are in the offing. Prices of cereals, particularly of wheat and rice, are also expected to remain firm due to constrained domestic supplies. This is likely to restrict the fall in food & beverages inflation in the following few months despite a favourable base. We expect food & beverages inflation to average at 6.6 per cent in the December 2022 quarter and 5.7 per cent in the March 2023 quarter.

Inflation in the fuel & light groups is also expected to ease gradually as crude oil prices soften globally due to weakening demand. In October 2022, the inflation fell to 9.93 per cent, after remaining in double-digits in five of the first six months of 2022-23. The fuel inflation is largely imported. Oil prices have been easing globally for the last 3-4 months. The recent cut in global oil demand forecast by OPEC suggests that the downward trend in prices will continue, with a probable short pause during the peak winter season. We expect inflation in the fuel group to average at 9.7 per cent in the December 2022 quarter and 8 per cent in the March 2023 quarter.

The core core inflation, that excludes these items, advanced in October 2022 to 6.53 per cent from 6.46 per cent in September 2022. The increase was small, yet significant as core core inflation now rules at its peak since January 2015. Inflation in clothing & footwear at 10.16 per cent in October 2022 remained virtually unchanged from the peak seen in September 2022. Inflation in household goods & services, personal care products & services, health, recreation and education didn’t show any large movement either. Inflation in each of these groups ruled either above or near six per cent in October 2022.

Going forward, we expect inflation in the core crore group to remain stubbornly high above the six per cent mark till March 2023. Prices of metals, chemicals, vegetable oils and cotton, the key inputs used for manufacture of household & personal care products have started softening globally. Supply-chains and logistics costs are also normalising. But Indian manufacturers and service providers are not expected to immediately pass on the benefits to the end users.

Prices of core core items are usually sticky. When input prices were rising in double-digits, Indian manufacturers and service providers absorbed the price rise partially. This is evident in the rise in raw materials-to-sales ratio of over 3,000 listed non-finance companies to 62.5 per cent in the first half of 2022-23 as compared to the decadal average of 58 per cent. Cost of power & fuel expenses as a proportion of sales also increased to 2.5 per cent as compared to the decadal average of 2 per cent. The companies reported a 23.7 per cent contraction net profits in the September 2022 quarter from the exceptionally high levels achieved during the Covid period. The net profit margin during the September 2022 quarter at 5.3 per cent was also a shade lower than the decadal average of 5.5 per cent. We expect companies to rebuild their profits instead of passing on the fall in input costs fully to the end users.

We estimate retail price inflation to fall below the six per cent mark only towards the fag end of the current fiscal. For the year as a whole, inflation is expected to average at 6.7 per cent, which would be the highest level seen in the last nine years. We expect inflation rate to moderate substantially to 5.2 per cent in the next fiscal i.e. 2023-24. However, it would still be far from the RBI’s inflation mandate of 4 per cent under the flexible inflation targeting framework introduced in 2016.