CPI inflation is expected to remain on target
The RBI (Reserve Bank of India) is confident about meeting the 6% target for CPI (consumer price index) inflation in January 2016. It noted that “Inflation has evolved closely along the trajectory set by the monetary policy stance.” A decline in the unfavorable base effect combined with prices of fruits, vegetables, and crude oil being low gave the RBI more confidence that CPI inflation will remain within the target range. In the following graph, the CFPI (Consumer Food Price Inflation) is released along with the CPI. Food Articles Inflation forms part of the WPI (wholesale price index). The divergence in their rate of change is due to their composition.
Let’s briefly look at what an unfavorable base effect means. The rate of CPI inflation, across the periods we showed in this series, has been calculated on a year-over-year basis. Let’s say that the index only saw a small rise in value from the previous month. However, a year ago, the index fell sharply. This will cause the percentage rise to be sharp, even with a marginal rise in the index value in a given month since the base—the previous year’s index value—is quite low. This is an unfavorable base effect.
CPI inflation going forward
The RBI expects CPI inflation to be around 5% by the end of fiscal 2016–2017. In India, a fiscal year begins in April and ends in March the following year.
In its forecast, the RBI assumed “normal monsoon and the current level of international crude oil prices and exchange rates.”
Investors should note that apart from the overall CPI inflation rate for December, the core CPI inflation rate, which excludes food and fuel prices, rose during the month. However, if we remove gas and diesel (MRO) (VLO) (CVX) from this, inflation was essentially flat.
Risks to the inflation forecast
The RBI hasn’t factored in the seventh Central Pay Commission’s revisions in the salary. The revisions are expected to put upward pressure on inflation. Also, monsoon rains and geopolitical events impact energy prices and financial markets. This provides uncertainty for CPI inflation’s expected path.
Investors in India-focused mutual funds (ETGIX) (WAINX) should continue to monitor CPI inflation. It will determine the duration for which the RBI continues to remain accommodative. A change in the repo rate will impact sectors that are sensitive to the interest rate. It will also impact industries like financials and autos.
In the next part, we’ll look at the macroeconomic picture in India. It’s outlined in the RBI’s February 2016 statement.