In line with the RBI’s projection for the first half of FY 2018, the consumer price index inflation dipped below the 2.5 per cent mark to record just 2.18 per cent in May 2017 — a five-year low. The numbers have surprised economists and bankers as they are far lower than their projections. Earlier this month, the RBI in its bimonthly monetary policy statement had projected that if the factors contributing to the April inflation — such as low prices of pulses and easing of inflation on items other than food and fuel — are sustained, then, despite the absence of policy interventions, the headline inflation would be in the range 2-3.5 per cent in the first half of the year and 3.5-4.5 per cent in the second half.
How has the decline been?
Inflation has declined over the last three years, the fall particularly noticeable over the last one year. From 8.33 per cent three years ago (in May 2014), it fell to 5.76 per cent in May 2016. After dropping below the 4 per cent mark in October 2016, the downward trajectory continued and in April it crossed the 3-per-cent to reach 2.99 per cent. The decline in May has been sharp, with a fall to 2.18 per cent.
What has led to this decline?
Food and beverages, which account for 45.86 per cent in the CPI index, have been at the centre of this decline. The food-and-beverages inflation has witnessed a sharp decline over the last one year. From around 9 per cent in May 2014, it came down to 7.2 per cent in May 2016. Over the last one year, it fell sharply and in April 2017 was 1.29 per cent before hitting a low of -0.22 in May 2017. The decline has also been propelled by a high base effect.
Within the basket of food and beverages, the sharp fall in inflation was led by a deflation in the prices for pulses and vegetables. While pulses (-19.45%) and vegetables (-13.44%) led the fall, low inflation on other items such as eggs (0.72%), fruits (1.4%) and spices (0.52%) too contributed to bringing CPI inflation down to 2.18 per cent. A report prepared by SBI group chief economic adviser Soumya Kanti Ghosh points out that vegetable prices are in the negative territory for the ninth straight month and pulse prices for the sixth straight month.
Core inflation (CPI excluding food, fuel and light, petrol and diesel), however, saw only moderate easing to 4.1%, compared with 4.2% in April, as inflation stayed stubbornly high in housing (4.8%) and education (4.9%).
Is inflation expected to remain at low levels?
There seems to be a broad consensus that inflation may remain at current levels for a couple of months more. However, even as it is expected to climb up in the second half, it is expected to be under 5 per cent. In its monetary policy announcement earlier this month, the RBI had projected that the headline inflation would be in the range 2.0-3.5 per cent in the first half of the year and 3.5-4.5 per cent in the second half. The SBI projected that while the CPI is expected to go under 2 per cent for the next two months, it will start climbing but will stay below 4% until November.
While accepting that the inflation numbers are lower than his expectations, D K Joshi, chief economist with Crisil, said that he expects inflation to be at current levels in the first half but to climb in the second half and possibly breach 4% by the end of FY ’18.
If the prices of pulses are reeling under the impact of a supply glut caused by record output and imports, the prices of vegetables have fallen markedly on account of significantly higher arrivals in mandis relative to the seasonal pattern. With IMD upgrading its initial forecast from 96% of the long period average (LPA) to 98%, the expectation is that it will have a positive impact on agricultural growth and in turn will impact food inflation. Even the SBI note points out that most inflation risks are now on the downside.
Will this lead to a rate cut?
Experts say that the RBI is not expected to take a call on rate cut based on April and May inflation figures. However, they expect rate cuts between 25 basis points and 50 basis points. While Joshi said that RBI may go for a 25-basis-point cut in repo rates this fiscal, Ashish Parthasarthy, head of treasury at HDFC Bank, said given the current inflation numbers in relation to what was expected, “There is room for a rate cut and I think that there is a room for up to a 50-basis-point cut in repo rates in this financial year.”
Also, given that industrial output slipped to 4-month low in February, mainly on account of a decline in the manufacturing sector and lower offtake of capital as well as consumer goods, the RBI would be under greater pressure to lower rates at its next review.