Sustainable disinflation in India will take time: UBS

Even if June inflation was unexpectedly lower.

UBS has noted that it believes Indian inflation is trending lower, a non-consensus call it has held since early 2014.

According to a research report from UBS, June inflation was lower than expected and added credibility to the authorities’ disinflationary policies.

However, that does not mean the disinflation dynamic will be smooth. Last month UBS highlighted the risk that a spike in oil prices could lift inflation. That risk has moderated.

In the immediate future, we believe the effect of the weak monsoon will be more noticeable for farm incomes and agricultural GDP than for inflation.

Here's more from UBS:

Nonetheless, although the monsoon rains have improved in recent weeks and government supply side policies promise to mitigate shortages, there is still potential for an upward impulse to food price changes to show up in the monthly price data followed by the RBI.

The key point is that although a weak monsoon poses a difficult set of circumstances for those directly affected, it should be a temporary phenomenon.

The policy effort to deliver lower inflation in India, meanwhile, is a multi-year process.

We do not expect a few of months with lower or higher inflation to deflect the authorities from their disinflationary policies.

The 7.3% June CPI inflation print was a surprise relative to our own and consensus expectations.

We judge from the RBI’s fan chart presented in the latest June Bi-Monthly Monetary Policy Statement that inflation in June was also below the central bank’s expectations.

Food prices accounted for much of the decline in CPI inflation due to their high weight, but the decline in inflation appears to have been broad based in non-food items as well.
The profile of the RBI’s projection in Figure 1 reflects the downward bias on CPI inflation in coming months as unseasonably large monthly increases in the CPI last year fall out of the 12 month inflation calculation.

However, this statistical bias will be reversed in the upcoming March quarter and could anyway be offset by temporary upward pressure arising from the weak monsoon.

In addition, we note that it will take time for excess capacity in the economy and soft monetary growth to combine with government supply side policy to depress inflation expectations hardened after 5 years of close to double digit CPI inflation.

As such we do not expect the central bank to rush to ease policy as a result of the lower June inflation print.

Only as it becomes more certain in the second half of FY 2015 that its glide path goal of 8% inflation in January 2015 may be beaten do we think the central bank will offer a token 25bp repo rate cut.

As such we expect RBI and government fiscal policy will remain restrictive into FY 2016.