Deutsche Bank Forecasts India's CPI Inflation To Fall Below 3% By July 2024

India's retail inflation rate could potentially drop to as low as 2.9 per cent by mid-2024, provided there are no unexpected food price shocks, and a favorable base effect plays a pivotal role.

Deutsche Bank's Chief Economist for India and South Asia, Kaushik Das, stated that as Consumer Price Index (CPI) inflation is expected to average 6.4-6.5 per cent in July-September 2023, it has the potential to dip below a 4 per cent average in July-September 2024, thanks to the exceptionally favourable base effect, assuming there are no significant food price shocks next year.

Presently, their forecast indicates CPI inflation at 2.9 per cent for July 2024, 3.3 per cent for August 2024, and an average of 4.5 per cent for January-March 2025.

The Reserve Bank of India (RBI) officially forecasts an average CPI inflation of 6.2 per cent for July-September, 5.7 per cent for October-December, and 5.2 per cent for each of the first two quarters of 2024. The last time inflation fell below the RBI's medium-term target of 4 per cent was in September 2019, when it stood at 3.99 per cent.

Das's remarks followed the release of data from the statistics ministry, which revealed that CPI inflation had decreased to 6.83 per cent in August, slightly lower than the consensus estimate of 7.0 per cent. This decline was primarily due to the decrease in prices of key vegetables, such as tomatoes, in the latter half of August, which brought down the headline inflation figure from July's 15-month high of 7.44 per cent. Many economists, including Das, anticipate a more significant disinflation in September, with inflation potentially dropping to as low as 5 percent based on current trends.

The CPI inflation data for September is set to be released on 12 October, shortly after the RBI's Monetary Policy Committee (MPC) announces its next interest rate decision on 6 October.

While the market has currently priced out expectations of rate cuts, Das believes the situation could change in the coming months as CPI inflation eases, particularly due to disinflation in vegetable prices. He anticipates the MPC to start cutting the repo rate by 100 basis points starting in April.

Das noted that historically, spikes in vegetable prices tend to result in higher-than-expected inflation figures, and the reverse is true when these prices correct sharply. He expects that, even in September, the actual CPI will likely surprise on the downside.

In August, food inflation dropped to 9.94 per cent from 11.51 per cent in July, primarily driven by a decline in vegetable prices, which were down 5.9 per cent from July. This followed a dramatic increase in July when the vegetable index surged by 38 per cent month-on-month (MoM), resulting in a 6.7 per cent sequential rise in the Consumer Food Price Index and a 2.9 percent increase in the overall CPI.

Das explained that in June and July, food prices experienced an almost 8 per cent MoM increase, whereas under normal circumstances, they would have risen by about 2 per cent MoM. This 6 per cent MoM excess spike in food prices, particularly driven by vegetables like tomatoes, led to the observed inflationary pressures.

He anticipates that only 3 per cent of this 6 per cent MoM excess spike in food prices will correct in September, representing a 50 per cent mean reversion, considering the risk of price increases in some food items apart from vegetables.

Despite the substantial volatility in vegetable prices, Das has not adjusted his inflation forecast of 5.3 per cent and 5.2 per cent for October-December and January-March 2024, respectively, opting to wait until September's data is available next month.