India inflation slumps in September

It fell sharply to 4.3% YoY.

CPI inflation fell faster than expected which solidifies HSBC's 25bp rate cut call for December.

"Looking through the data, we get a sense that the recent fall in food prices may have a structural element to it. Some Indian states have been undertaking food distribution reforms and the food price declines may not reverse in a hurry," it said in a report.

 Alongside, after remaining stubbornly high for about two years, core inflation has also softened a touch over the last quarter.

HSBC notes that if food prices remain contained, core inflation could soften further through the inflation expectations channel.

"The RBI's assessment that real neutral rates in India may have fallen a notch over time, and the clarification that the central bank is targeting inflation more flexibly (in the 4%, +/- 2% band) are also supportive of our rate cut call," it said.

Here's more from HSBC:

Food prices have fallen faster than expected, some structural forces may be at play.

September CPI fell sharply to 4.3% y-o-y (vs. 5.0% y-o-y in August) as food prices softened further. The headline print was lower than consensus and our expectation of 4.6% and 4.7% respectively. In sequential terms, inflation fell 0.3% m-o-m sa following the 0.2% decline in August.

Today's 70bp fall in headline inflation was almost completely on the back of lower food prices. The sequential momentum in vegetables and pulses fell markedly (-7.6% m-o-m sa and -3.1% m-o-m sa respectively).

Through the scorching summer when food prices had soared, we held on to our rate cut call on the back of the weather bureau's prediction of near-normal rains. But the pace of food disinflation has been faster than we had anticipated.

Looking closer, we get a sense that some structural forces may also be at play. Some of India's states have been undertaking food distribution reforms recently. For instance, Maharashtra liberalized trade in fresh foods in July this year. Karnataka has emerged as a leader in digital food markets. These states have seen a sharp fall in food prices recently, all of which may not reverse in a hurry (see chart 2).

Core inflation has inched a notch lower.

After being stubbornly stuck at the 5.5% y-o-y level (between mid-2014 and mid-2016), core inflation has finally lowered a notch over the last quarter (averaging 5.2% y-o-y). We see a similar softening in sequential terms as well. Core prices rose 0.2% mom sa in September, a touch lower than the 0.3% m-o-m rise in August and an average 0.5% m-o-m growth over the last two years.

It is likely that if food inflation is kept low on the back of structural reforms, it could soften core prices further over time (see: India RBI Watch: What's not to like?, October 29). Some may rightfully ask that if softening food prices matter so much, why didn't core inflation fall over the last year when food inflation was moderating? And here, we have a nuanced answer. Inflation expectations are impacted by various factors, one of them being the dominant impact of a few crops that remain inflationary despite prices of all others falling. Recall that pulse inflation remained high through the last year (35 percent year-on-year) and this probably prevented inflation expectations falling by too much. It helps here that pulse production has been strong this year and prices have been falling rapidly in recent weeks.

We expect RBI to deliver a 25bp rate cut in December.

The RBI's recent assessment that real neutral rates in India may have softened over time, and its clarification that the inflation target is 4%, +/-2%, (rather than a precise 4% by early 2018), makes us more confident of our rate cut call (see: India Economics: RBI's newly formed MPC unanimously votes for a 25bp rate cut, October 4). We see CPI inflation to remain in a comfortable range - undershooting RBI's 5% target of early-2018, and averaging 4.75% over the next 12 months.

The horizon beyond the 25bp rate cut is hazy. There are some policy-related upside risks to inflation in the second half of 2017, such as the second round effects of the government wage hikes and a temporary spike in inflation if GST rates are over 18 percent. Some could be overlooked by the RBI given that they would be a one-time jump in inflation. But only when the scale of the increase is known, (which will take time), would the RBI be able determine how much of the impact can be safely overlooked.

In light of these risks and the RBI's desire to eventually move towards the mid-point of the 4 percent +/-2 percent band, we expect the 25 bps rate cut in December to be the last in the cycle.