The continuation of low wholesale inflation was driven by (1) across-the-board sequential fall in manufactured products prices and (2) continuing fall in primary articles and fuel prices. In line with the retail inflation print, the wholesale inflation provides further comfort on the disinflationary process. We factor in 75-100 bps of rate cuts in CY2015 based on global (Eurozone, US) and domestic (fiscal, growth) conditions.
Benign commodity prices drag down manufactured products prices
Commodity prices globally have remained benign and the effect was clearly showing in broad-based decline in manufactured products prices. We note that of the 12 broad components, all except food products and wood and wood products have either remained flat or declined on a sequential basis. The effect of muted metal prices globally have led to basic metal inflation turning negative ((-)0.2%) on a yoy basis while falling crude prices have led to consistent sequential decline in the chemicals segment. These two components contribute 20% to overall WPI and 35% to manufactured products index. Core inflation (manufactured products ex-food inflation) dropped further to 1.6% with mom decline of 0.3%. With commodity prices expected to remain low and in the absence of any sharp pick-up in domestic demand, there is unlikely to be much upside in core inflation in the near term.
Food and fuel continue to contribute to lower inflation
Moving away from positive base effects, primary articles inflation picked up to 2.17% in December (from (-)0.98% in November). However, primary articles inflation dropped 1.3% sequentially with food articles prices declining 1.9%. Vegetable prices continued to decline sequentially (7.7%) though high frequency data that we track indicated more muted decline. Cereal prices also declined sequentially for the fourth month. Reflective of falling crude prices, the fuel price index continued to drop. The December print was (-)7.8% yoy with sequential decline of 2.4%. Petrol and diesel registered mom decline of 2.1% and 2.3% respectively.
WPI inflation could enter negative zone
With the WPI basket more heavily loaded with items whose prices are dependent on global trends, going forward, our extrapolated model indicates that the headline WPI inflation will in all likelihoods move into a negative zone with the continuing deflationary trend in the global economy. At this point of time, we are not too sure if a new round of monetary injection by the ECB will have the same effect on global commodity prices as did the QE1 of the Fed. Adding to the global downshift of commodity prices will be the relative stability that the INR has exhibited of late. However, WPI moving to the negative territory is unlikely to be construed as ‘deflation’ in the true sense of the term as India is unlikely to have any significant demand-side problems.
Probability of monetary easing in February has increased
While the implication of the global crumble in commodity prices is now more critically felt on the WPI inflation, it is expected to impact retail prices with a lag. This is because the manufacturers would likely use the current opportunity of decline in input prices to expand their business margins that had contracted significantly in the past few years when global commodity prices were on the higher side. However, the trend in the WPI inflation does indicate that currently downside risks to the CPI are probably more than the upside risks. Hence, we feel the RBI would be comfortable in changing stance and we place a bigger probability for the RBI to start the monetary accommodation as early as in the February policy meeting itself.
By Indranil Pan, Chief Economist, Kotak Mahindra Bank