India’s Wholesale Price Index draws a surprising decline

Rate cuts loom in 1H2013 amidst lower- than-expected drop to 7.24%.

India’s headline WPI inflation fell to a lower-than-expected 7.24% y-o-y in November from 7.45% in October. Food inflation (primary and manufactured) rose to 9.0% y-o-y from 7.7%, while core inflation (non-food manufactured) fell sharply to 4.5% y-o-y from 5.2%; fuel prices also declined to 10% from 11.7%.

According to Nomura, the positive surprise came across-the-board. First, primary articles inflation rose less than expected due to a sharp 2.4% m-o-m decline in mineral prices, more than offsetting the rise in primary food and non-food prices in the month. Second, the fuel index fell 0.6% m-o-m reflecting the lagged effect of lower oil prices. Third, manufacturing inflation rose by a muted 0.1% m-o-m, compared to an average of 0.5% over the past five months due to a sharp fall in cement, metal, chemical and leather prices.

Nomura however believes that today’s reading is not yet the start of a trend as it expects momentum in inflation to rise. This is also reflected in the continuing upward revisions with the September WPI revised higher to 8.07% from 7.81%.

Here’s more from Nomura:

In our view, today’s surprise is due to a delayed downward adjustment in the WPI basket reflecting the benefits from INR appreciation in September. Both the input and output price sub-indices of the manufacturing PMI rose sharply in November, suggesting this downtrend has reversed. Historically, we find the PMI price indices a good lead indicator for momentum in WPI inflation.

What is the likely inflation trajectory? Food prices usually decline during the winter months. This did not happen in FY11, which caused year-on-year food inflation to fall sharply in the winter months of FY12. In FY13, food prices have been following a normal pattern and therefore food inflation should not spike too much, in our view. Market-determined fuel prices have already risen in December reflecting INR depreciation in October/November. Further, we believe that core inflation is close to its trough as suggested by the rise in the PMI output price index. Even as month-on-month momentum is likely to pick up, base effects are likely to ensure that headline year-on-year WPI inflation remains around the November level in December and eases to around 7% by March. Inflation is unlikely to sustainably fall below 7%, in our view, as global commodity prices and INR/USD remain in a range.