Inflation numbers well on track, but what Budget offers to revive industrial growth this year will be interesting to watch

The Consumer Price Index (CPI) inflation number is always of interest because the level largely determines RBI action. Rates that seem to be low in the region of 3 percent have spurred rate cut action by the Reserve Bank of India (RBI) and by implication similar levels will increase the demand for rate cuts along the way.

Also, the composition of CPI is important because while the monetary policy committee (MPC) targets the headline number, the breakup into food and core becomes important as it could weigh in the minds of the MPC members. The food inflation trajectory is important as it influences the headline number without being affected by rate action. Core inflation is the serious part that can be affected by monetary policy action and hence the direction becomes critical.

Headline inflation for May is 3.1 percent which comes over 3 percent in April. The number is quite clearly below the 4 percent mark and hence does not spark concern. It is more so because the RBI had projected 3-3.1 percent for the first half of the year. Therefore, the CPI number is well on track. Will it continue to be within the range in the next four months? For June and July, a high base effect will definitely keep it down, and it could go lower too. There could be an upward tendency in August and September where the base effect weakened. The critical part in the next 4 months will be how the food prices behave.

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Food inflation has been low at 1.2 percent and the two possible problem areas are vegetables and pulses which had negative inflation for a long time but have risen to 5.5 percent and 2.1 percent respectively. A seasonal factor for vegetables and a possible depletion of stocks for pulses could be the explanation. This will be affected a lot by the monsoons and while the India Meteorological Department (IMD) and Skymet have slightly different scenarios painted this year, the arrival, progress, spread and departure will play a vital role here. Pulses are vulnerable to monsoons as irrigation facility is limited. Tracking the monsoon progress will be important as production is concentrated in the rain shadow area.

Representational image. Reuters

The core inflation part is also interesting and has been range bound in the 4-5 percent bracket. This number has been influenced by institutional factors given the way it has been calculated. This means that changes take place periodically and would show a spike when the change takes place and subsequently indicate a decline. For instance, the housing costs, which are based on the pay commission scales.

There was a phase of implementation last year which pushed up these costs and hence the index. But the same high base will help bring down the number statistically this year as there will be no incremental cost. The same holds for health and education which have witnessed inflation of 8 percent and 6.7 percent respectively in May due to medical and education costs/fees which are revised periodically. In FY20, typically these indices should witness a decline as the peak was scaled last year.

Therefore, core inflation will continue to move downwards while food inflation will be more volatile and probably increase. The statistical advantage witnessed last year will wean gradually and push up prices. Further, the advance of the monsoon and the kharif prospects will have a bearing on prices. In fact, the market reacts very fast to monsoon news as all the crops grown are single-season ones where the harvest of last year is stored and streamed into the system over a period of 12 months until the next crop arrives. Hence any news of disruption in sowing gets transmitted to the mandi prices as the intermediaries storing the crop tend to increase the price as ‘hoarding, and speculation takes over.

While the government gives the assurance that there are large stocks with the Food Corporation of India (FCI), it must be pointed out that this refers to rice and wheat only. Food inflation historically has been caused by pulses and horticulture and to extent vegetable oils. The last may not be a problem as imports are the major supply factor and with global prices being benign should not exert pressure on prices in case of domestic crop shortfalls.

The Index of Industrial Production (IIP) growth number does surprise at 3.4 percent as it was least expected and also because it comes over a negative growth number in March. The heartening part is that growth appears to be well-dispersed across all segments – mining, manufacturing and electricity. Even in terms of use-based classification, it was relatively sharp for primary, capital and consumer goods. Infra growth was low at 1.7 percent which was expected given the lower performance of the core sector industries. On the whole, it is satisfying.

It would, however, be difficult to extrapolate this number over the next few months as it is a single month phenomenon. Also, the base effect will weigh heavily up to October as growth was higher in 2018 which will exert downward pressure. More importantly, we need to see a genuine revival in consumption and investment. Consumption trends would tend to be more visible in the second half though April-May is also important months given the spending from the rural economy post-rabi crop.

The investment will be low-key for two reasons. Government spending was limited just before the elections and most of the allocations would have been to compensate for the rollover of payments on subsidies last year into this fiscal. Further, prior to the elections, governments normally do cut back on capex. The private sector too is cautious until it hears something new from the new government (even if it is the same on that comes back to power). Therefore the path will be gradual.

Industrial growth is the key to employment generation and hence will be the focus of the attention of the government this year. ‘How to revive growth’ will be the main theme and it will be interesting to see what the Budget offers to the manufacturing sector this year.

(The writer is chief economist, CARE ratings)