India: Decoding the drivers of food and core inflation

Transcription

1 In Focus: Occasional Treasury Research Group For private circulation only India: Decoding the drivers of food and core inflation Short-term food inflation within the CPI basket is driven by drivers such as government policies, global price parity and infrastructure facilities, while the long-term outlook based on supply and demand depends on changing dietary patterns with rising per capita income levels. The traditional Philips curve relationship of output gap (reflecting demand based pressures) leading to increase in inflation especially the core components holds true. Headwinds to food inflation this fiscal emanate from 1) likelihood of substantial MSP increases 2) sharp Rupee depreciation, while the recent pace of closing of negative output gap exerts significant pressures on core inflation. Given these factors, along with possible risks from factors such as oil prices and monsoons, we expect the RBI to raise rates once more in FY2019, either in August or October. June 27, 2018 Please see important disclaimer at the end of this report Anushri Bansal Food inflation dependant on a host of underlying price drivers; long term outlook depends on increase in per capita income levels but threat is limited Given the importance of food (~40%) in the retail consumption price basket, we look at underlying price drivers of ~60% of the food basket. Driven by government policies, global price parity and infrastructure: Following factors play important roles in food price dynamics 1) government policies on procurement, food grain stock management and MSP for cereals 2) global prices and sharp currency movements for import/export dependant goods pulses, meat and fish 3) production yields and transport and storage infrastructure for fruits and vegetables. Limited threat from changing dietary patterns with increased in per capita income levels: Moreover, we look at the supply-demand dynamics in the long term, keeping in mind changes in nutritional consumption basket with increase in per-capita income levels. Our research finds that for most components of the food basket we are already meeting our daily nutritional requirements thereby posing limited threats to prices from increased income levels. This also holds true for meat and fish, whose prices are considered vulnerable to increases in income levels and shifting dietary patterns. The only deviation being vegetable prices, where growth in demand with increased income levels is expected to outpace the growth in supply (given poor yields and infrastructure facilities), underscoring the need for policy action to mitigate these risks. Output gap movements indicate that demand based pressures have a positive influence on core inflation An economy with a positive output gap is likely to witness inflationary impulses, while one with a negative output gap is running below its potential, leading to deflationary pressures. Our research shows that a 1% increase in output gap leads to a ~8-11bps increase in core month on month (MoM) inflation with a lag of 1-3 months, indicating the existence of the traditional Philips curve relationship for India. The extent of impact on inflation depends on the pace of increase, the position in the business cycle along with other factors such as 1) past inflation (capturing adaptive expectations) 2) supply shocks exchange rate movements and crude oil prices 3) food inflation Expect RBI to raise rates once more this fiscal, given headwinds from underlying price drivers of food inflation and closing of output gap The currently benign food inflation seems under threat given the headwinds of possibility of substantial MSP raises for Kharif crop and Rupee depreciation seen this fiscal and expectation of continued depreciation bias on account of 1) real rate differentials with continued tightening of US monetary policy, 2) trade wars and 3) overall vulnerability to global risk

2 Data Release sentiment. Moreover, the closing in of the output gap has been exerting significant influence on month on month movements of core inflation. Given these factors, along with risks from supply shocks: oil prices and monsoons, we expect the RBI to raise rates once more in FY2019, either in August or October, depending on how the inflation trajectory evolves. Food inflation: Dependant on a host of underlying price drivers; increase in per capita income levels limited threat to long term outlook Given the importance of food (~40%) in the retail consumption price basket, we look at underlying price drivers of ~60% of the food basket. The table gives the key factors driving prices for cereals, pulses, fruits and vegetables and meat and fish, along with their future outlook based on increases in nutritional demand with per capita income levels. Weight in CPI (%) Food Cereals Pulses Fruits and Vegetables Meat and Fish Food Inflation - underlying price drivers Factors driving prices Government policies: 1) MSP 2) food grain stock liquidation 1) Domestic production 2) Global prices and import policies 1) Production yields 2) Poor transport and storage infrastructure 1) Export price parity 2) Exports as a % of domestic production Source: FAO, CEIC, ICICI Bank Research Future outlook: Nutritional demand with increase in per capita income Per capita intake is in line with global averages Domestic production and imports to meet demand Vegetable demand to increase- CAGR of ~3% - risk to prices Expected CAGR of ~1% - production to meet demand Cereal inflation largely driven by food grain management and MSP increases: Barring a sudden deficit of cereal production on account of supply shocks like droughts, cereal prices are determined by government policies on 1) procurement and food stock liquidation 2) MSP hikes. The double digit cereal inflation witnessed in FY2012 and FY2013 was on account of a double whammy of ~18% of MSP hikes (cereal CPI weighted average basket, Kharif season) along with hoarding of crops by the government leading to cereal stocks of ~235% more than the mandated buffer norms. In contrast the moderate single digit cereal inflation seen between FY2015 FY2018 could be attributed to 1) moderate MSP hikes (averaging ~4.3%) for the Kharif season and 2) liquidation of stocks by a CAGR of -9.2% in the last five years. 2

3 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Data Release Government stock management policies play a key role in cereal inflation Stock of Cereals Buffer Norms CPI Cereals (RHS) (Mn tonnes) Source: FAO, CEIC, ICICI Bank Research MSP has a strong positive impact on CPI inflation Weight in CPI (%) CPI CPI Food CPI Cereals MSP for Kharif cereal crop (% YoY) Mar Mar Mar Mar Mar Mar Mar In this regard, the pending MSP announcements for the Kharif season crops for FY2019, with a conservative expectation (using 1.545x A2+FL) of a weighted average increase of ~12.8 for cereals and the already recommended MSP hikes for pulses (pulses CPI weighted average basket, Kharif season) of 9.2% could lead to pass-through impact on headline inflation of ~50bps. 3

4 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Data Release Impact of MSP increases on headline CPI inflation CPI FY2019 weights expectation s (%) FY2013 FY2018 C on servative : 1.545x A2+FL for cereal crops Paddy (Common) Jowar Bajra Maize Ragi Tur Moong Urad Groundnut in shell Weighted average YoY increase in MSP (%) CPI direct impact (bps) Estimated pass through to CPI headline (bps) Pulses inflation largely driven by domestic production and global prices: The double digit deflation seen in pulses since September 2017 can be largely attributed to a 1) domestic supply glut, with domestic production reaching 24.5 mn tonnes in FY2018 from the lows of 16.4 mn tonnes seen in FY2016 2) crash in global prices with continued imports (averaging 30% of domestic production) despite the domestic supply glut. Pulses is a big source of protein for most of the Indian population, hence the trajectory of future prices would be dependent on government policies on MSP and procurement management on one hand, and global prices and import policies on the other Pulses inflation driven by domestic supply and import policies Domestic Production of Pulses (RHS) CPI Pulses (%) Import as % of domestic production (Mn Tonnes)

5 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Data Release Fruits and vegetable price volatility due to poor infrastructure and perishability: Despite the government push towards horticulture, prices of fruits and vegetables are very volatile on account of poor yields (for vegetables) and poor infrastructure for storage and transport leading to losses of around 6.6% of production. (FAO) This is evident in the fact that volatility in vegetable inflation is 15.8% compared to the volatility of overall food inflation of around 4.3% from March 2012 April Moreover, demand for vegetable consumption is expected to rise by a CAGR of ~3% with increase in per capita income levels. This implies further pressure on prices with changing consumption patterns. Government intervention to improve vegetable yields as well as provision of infrastructure facilities to minimise the losses is an urgent requirement to stem the current price volatility seen in this group. Fruits and Vegetables: Volatility in prices a function of poor yields, perishability and lack of storage facilities Weight in CPI (%) CAGR Production % ( ) CAGR Yield (Kg/Hectare) Losses (%) ( ) Volatility in inflation (%) Vegetables Fruits Food Source: CEIC, FAO, ICICI Bank Research Highly volatile CPI fruit and vegetable inflation 25.0 CPI Fruits CPI Vegetables (RHS) Meat and fish prices dependent on Rupee movements and export demand: Contrary to popular belief that changing consumption patterns towards meat and fish with rise in income levels are the biggest levers to prices in this category, our research finds that sharp depreciation of the Rupee as well as export demand are more dominant factors driving prices. The double-digit inflation seen in calendar year 2012 and 2013 is juxtaposed with sharp currency depreciation. This was also the time Indian meat markets opened up with 5

6 Data Release exports as a % of domestic production rising from 22.9% in 2012 to 31.4% in Given the socio-religious considerations our growth in demand for meat and fish with increase in income levels, will be lower than global averages. Moreover, our supply in terms of production and exports would be more than sufficient to meet growth in demand. Thus prices even in the long term, are likely to be determined more by sharp movements in the currency and export demand rather than our own consumption patterns. Meat and Fish: Growth in production sufficient to keep pace with growth in demand and exports (%) Weight in CPI CAGR Production ( ) CAGR Exports ( ) Expected CAGR of growth in demand ( )* Meat and Fish Source: CEIC, FAO, ICICI Bank Research Core Inflation: Output gap movements indicate demand based pressures have a positive influence on core inflation We next look at how demand based pressures indicated by movements in the output gap, have an influence on core CPI inflation. An economy with a positive output gap is likely to witness inflationary impulses while one with a negative output gap is running below its potential, leading to deflationary pressures. An increase in the output gap when the economy is running above potential and a decrease in the negative output gap when the economy is running below potential would have a positive influence on prices and inflation through demand based pressures. Our research finds that a 1% increase in output gap leads to an 8-10bps increase in MoM core inflation with a lag of 1-3 months. The extent of influence depends on the pace of increase and the point in the business cycle. In order to capture the relationship, we first calculate the output gap, which is the difference between potential output and actual output. Using quarterly real GDP as a proxy for actual output, we calculate potential output using the HPfilter approach. 6

7 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Data Release India's Potential Real GDP Growth Rate lower than its pre-crisis peak 9.0 Potential GDP real growth Potential GDP excluding government real growth Potential GDP growth rate 5 year average Source:CEIC, ICICI Bank Research Actual GDP Growth Rate is nearing its potential GDP Growth Rate (%) Real GDP output gap 4 period MA Real GDP excluding government output gap 4 period MA Source:CEIC, ICICI Bank Research Output gap movements signifying increase in demand pressures has a positive impact on inflation: The extent of impact on inflation depends on the pace of increase, the point in the business cycle along with other supply side measures such as 1) past inflation (capturing adaptive expectations) 2) supply shocks exchange rate movements and crude oil prices 3) food inflation The existence of this relationship gives credence to monetary policy action based on movements in the output gap enabling the central bank to take preemptive monetary policy decisions, which would help, manage inflationary expectations as well as cement the credibility of the central bank. 7

8 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Inflation Data Release Positive correlation between inflation and output gap 3 MMA (% MoM) CPI Core inflation excluding transport CPI Inflation Real GDP output gap (%) Movements in output gap exert positive influence on core inflation CPI Core inflation excluding transport (3MMA % MoM) st differential real GDP output gap (RHS) (%) Expect RBI to raise rates once more this fiscal, given headwinds from underlying price drivers of food inflation and closing of output gap The currently benign food inflation seems under threat given the headwinds of substantial MSP raises for Kharif crop and Rupee depreciation seen this fiscal and expectation of continued depreciation bias on account of 1) real rate differentials with continued tightening of US monetary policy, 2) trade wars and 3) overall vulnerability to global risk sentiment. Moreover, the closing of the output gap has been exerting significant influence on sequential movements of core inflation. Given these factors, along with risks from supply shocks: oil prices and monsoons, we expect the RBI to raise rates once more in FY2019, either in August or October depending on the evolution of the inflation trajectory. 8

9 Data Release ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai Phone: (+91-22) Treasury Research Group Economics Research Kamalika Das Economist (+91-22) (ext 6280) Shivom Economist (+91-22) (ext 6273) Chakravarti Anushri Bansal Economist (+91-22) (ext 6220) Sumedha Economist (+91-22) (ext. 7243) Dasgupta Ramakrishna Economist (+91-22) (ext. 6943) Reddy Bogathi Ashray Ohri Economist (+91-22) (ext. 7249) Pradeep Kumar Economist (+91-22) (ext. 6272) Yash Panjrath Economist (+91-22) (ext. 8161) Sparsh Chhabra Economist (+91-22) (ext. 7309) Sri Kadiyala Economist (+91-22) (ext. 7206) Treasury Desks Treasury Sales (+91-22) Currency Desk (+91-22) Gsec Desk (+91-22) FX Derivatives (+91-22) /43 Interest Rate Derivatives (+91-22) Commodities Desk (+91-22) Corporate Bonds (+91-22)

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