India’s inflation alarming at 9.8% in August

Approaching double-digits: WPI inflation rise further in August
India's August WPI headline inflation rose to 9.8% y-o-y (vs. 9.2% in July), above consensus, and core inflation continued to trek up. Despite global economic weakness, RBI's primary concern remains inflation and further tightening is needed, with a 25bp rate hike expected this Friday.

Facts
WPI inflation rose in August to 9.8% y-o-y (vs. 9.2% y-o-y in July), which was above consensus (9.6%) and our forecast (9.5%). On a sequential and seasonally adjusted basis, inflation accelerated to 0.6% m-o-m (vs. 0.1% in July).

Of concern, core inflation (non-food manufacturing) continued to rise, coming in at 7.6% y-o-y (vs. 7.3% y-o-y in July).

Moreover, sequential core inflation accelerated slightly to 0.4% on a m/m sa basis (vs. 0.1% in July). This was driven by a relatively broad-based increase across core items.

Primary food inflation rose to 9.6% y-o-y (vs. 8.2% in July), with strong increases for rice, vegetables, potatoes, onions, and fruit. Turning to minerals, inflation eased to 23.4% y-o-y (vs. 25% in July). However, it increased for non-food primary articles (17.8% vs. 15.5% in July) and 'fuel & power' (12.8% y-o-y vs. 12.0% in July).

Historical data were yet gain revised up, but encouragingly only marginally this time around. June's WPI reading got pushed up from an original estimate of 9.4% to now 9.5% y-o-y.

Implications
The high-inflationary environment is clearly not going away anytime soon, with underlying inflation pressures firmly in place.

Moreover, there are further upside risks to the inflation outlook.

As we have mentioned before, core inflation is now a key driver of inflation, which reflects that still robust domestic demand provides businesses with pricing power and, combined with tight capacity, is also pushing up wages.

The latter is evident from various manpower surveys and from the still solid sequential growth in HSBC's PMI service sector input prices (mostly wage costs).

But, fuel inflation is also on the rise and got a shot in the arm recently from the adjustments to diesel and other controlled fuel prices, which are estimated to add a total of 1 percentage point to inflation, factoring also in the second-order impact.

Moreover, food price inflation picked up in August, which cannot be explained by base effects as food inflation decelerated in August last year. This is also of concern.

From RBI's perspective, today's numbers confirm the need for continued tightening, although the weak global backdrop deserves close monitoring. On the domestic side, the economy is showing signs of moderation as expected following several policy hikes, but there are no signs of a collapse in growth. This means that domestic sources of growth are still strong enough to keep underlying inflation pressures firmly in place, considering that we are currently in a situation with excess demand. On the external side, on the other hand, the global economic conditions have clearly worsened since the last policy meeting and uncertainties about the global outlook are also now much higher.

However, given the domestic orientation of the economy and the persistent rise in core inflation, the domestic factors still dominate at this stage and we expect that the RBI will hike by 25 bps this Friday. This will lift the policy rate out of the "neutral zone" and into contractionary territory, which is where it needs to be before the RBI can rid of the excess demand.

Bottom line: The August WPI reading confirmed that inflation remains too high for comfort, with core inflation still rising. As such we expect that RBI will hike this Friday by 25 bp.