"The contribution of ‘housing’ and ‘education’ prices is increasing"
The overall CPI inflation increased to 7% in August largely driven by consumer food prices. Both Rural and Urban CPI surged in August as compared to July, the increase in Rural CPI is more pronounced. Rural CPI increased by 35 bps m-o-m to 7.15% in Aug mostly due to 312 bps m-o-m increased in cereals prices.
A decomposition of CPI food inflation into sub-components show that on a weighted contribution basis, the food inflation was driven by cereal products and vegetables. The seasonal impact of rains on vegetable prices was discernible. The prices of cereal have moved higher despite consecutive fall in cereal prices in international markets. Spatial variation in rains and acreages across crop segments has affected the prices movements. With opening of sea routes in Black Sea there could be some moderation in cereal prices, but the general picture is not uniform across various cereal segments.
The most interesting trend is the negative growth in protein rich item eggs and steady deceleration in prices of meat and fish. This trend is rather surprising as current period of high inflation is not driven by protein rich items. Overall, with resumption of good movement from Black Sea the prices of various food items such as oil will see some moderation. Fluctuation in output due to climatic factors and high cost of transport still underscores the need to be watchful of inflation in general.
Using the idea from the recent paper by Shapiro (How Much Do Supply and Demand Drive Inflation? FRBSF Economic Letter, June 21, 2022), we have sliced CPI inflation into Supply/Demand CPI and Neutral. Our analysis shows that out of 299 commodities in CPI, 171 are categorized as supply driven, 99 as demand driven and 29 are neutral. Our results show that supply side factors which were responsible for 65% of CPI inflation in May had dropped to 58% in Jul but has increased to 61% in August possibly reflecting the increase in unseasonal rains. Interestingly, demand factors continued to remain range bound and the contribution of demand seemed to have slowed down in August, though marginally. Clearly, the jump in inflation in India continues to be a by-product of supply disruptions.
With the rising prices, goods inflation (with weights 70%) is moving in tandem with the overall inflation, grew by 7.9% in August 2022, compared to 7.5% in July . In contrast, Services inflation, which accounts for a weight of 30%, is declining and is at 5.0% in August 2022. This again substantiates that the current inflation is mostly supply driven. Among services, the contribution of ‘housing’ and ‘education’ prices is increasing, indicating the real estate market has now significantly recovered from the pandemic blues.
We believe the RBI is likely to raise rates in September policy and it could be a close call between 35 and 50 basis points. Beyond September, we are penciling in a minimal and token rate increase as inflation is likely fall in a jiffy in H2FY23.
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