India’s core inflation critical at 5.2%

Headline inflation and core inflation give a mixed picture on price pressures in the coming months. Headline inflation remained manageable, reaching 4.8% YoY in August. Food and fuel price increases during the month continued to moderate.

However, the big spike in core inflation is worrying. Core inflation reached 5.2%, breaching the critical 5% mark for the first time in 25 months. On a sequential basis, there was a 1.1% MoM increase, a feat not seen since mid-2008 when there was a hike in subsidized fuel prices. Using the breakdown of headline CPI as a gauge, the largest contributor to higher prices is from the ‘clothing’ component, which saw prices increase by 3.1% MoM (11.4% YoY). And the bulk of this can probably be attributed to the 12% increase in gold prices from July to August.

However, it is still difficult to reconcile a sharply rising core inflation rate and still-mild headline
inflation rate. In our view, sharply rising gold prices have distorted price pressures as measured by the CPI. If gold-related items are stripped out, both core and headline inflation would show a much more comfortable pace of price increase. As such, we still do not expect BI to hike the policy rate on Thursday.

But this does not mean that price pressures are not mounting. Aside from clothing, the ‘education and recreational and sports’ component also showed a 2.1% MoM increase in August. Even after accounting for seasonal adjustments, the figure is still elevated compared to the preceding years. With growth still chugging along at a brisk pace, we are still penciling in two 25bps rate hikes in 4Q. However, with the external outlook still very uncertain, downside risks to this view dominate.