We expect inflation to be in the 10-11% range in the next two months, though food article inflation is easing, inputs in manufacturing are on the rise putting pressure on prices.

Source: CAPITAL MARKET

Inflation set to cross double digit in March 2010 as the effect of rise in fuel prices including second level pass through of road freight rates, increase in excise duties takes place 

India's WPI based inflation for February 2010 accelerated further to 9.9% from 8.5% in January 2010 and 3.5% in February 2009. This was the highest reading in last 16 months since 11.1% recorded in October 2008. At this level, inflation is just 290 basis points lower than the peak level of 12.8% achieved in August 2008. 

The inflation plunged to a three decades low of (-) 1.0% in June 2009 and remained at sub-zero level for three month up to August 2009 with improving bias. It turned positive in September 2009 and accelerated further with the strong support from sharp rise in the prices of food articles and food products. The food prices remained at elevated level, while the prices of fuel products and other manufactured products started racing ahead from November 2009 and drove the inflation to 16 months of 9.9% February 2010. 

The growth of inflation for February 2010 was 133 bps higher at 9.89% compared to 8.56% in January 2010. The 65 bps of the 133 bps spike in inflation for February 2010 was contributed by fuel, power, light and lubricants group, followed by 50 bps from manufactured product group and rest from primary articles group.

The most of the incremental inflation during February 2010 was largely caused by partial rollback of fiscal stimulus packages announced in the wake of global financial and economic recession. The Union Budget 2010-11 announced on 26 February 2010 raised the excise and custom duties for various products including petroleum as well non-petroleum products. Meanwhile, the declining low base last year has also helped the inflation to improve higher in February 2010.

The custom duty of 5% on crude petroleum; 7.5% on diesel and petrol and 10% on other refined products was restored, while central excise duty on petrol and diesel was raised by Rs 1 per liter each in Union Budget 2010-11. This necessitated hike in domestic price of petrol by Rs 2.7 to Rs 47.43 a liter and by Rs 2.6 to Rs 35.47 a liter for diesel on 27 February 2010. Thus, the inflation for petrol and diesel zoomed to 11.7% and 8.8%, respectively, in February 2010 from 0.0% and 1.1% in January 2010, and contributed 41 bps of incremental inflation in February 2010.

The excise duty on non-coking coal, which account for more than 92% of the coal production in India, was increased from 8% to 10%. Meanwhile, Clean Energy Cess has been levied at Rs 50 per tonne on both coal produced in India as well as imported coal. The inflation for non-coking coal surged to 14.8% in February from 3.0% in January and contributed 18 bps to the incremental inflation in February 2010. 

The excise duty on steel product was increased from 8% to 10% in the Union Budget 2010-11. This pushed the inflation for basic metals and alloy group from (-) 3.3% in January 2010 to 1.8% in February 2010, with steel prices on rising path, and contributed 39 bps of the incremental inflation in February 2010. The hike in excise duty also impacted the prices of non-ferrous metal, which contributed 11 bps of spike in inflation during February 2010.

The wholesale price index for all commodities rose 0.6% (to 250.1 in February 2010 from 248.5 in January 2010) during February 2010, recording m-o-m increase for twelfth sequential month. Among the three major commodities group, the index of primary articles remained unchanged during February 2010 with food index declining 0.1% and non-food index rising 0.1% in February 2010 from January 2010. The index of Fuel, Power, light and Lubricants zoomed 1.5% during February 2010 from previous month, recording rise for eleventh straight month, as coal mining group surged 10.5% while mineral oil group soared 1.0% during February 2010 from January 2010. 

The index of Manufactured product, which carries the largest 63.75% weight among three major commodities group, rose 0.6% in February 2010 from the previous month. Among the 12 sub-groups under manufactured product group, the index of leather and leather products and Machinery & Machine Tools declined 0.8% and 0.6%, respectively. Meanwhile, the weighted subgroup such as food products, chemical products and textiles witnessed increase of 0.4%, 0.3% and 0.9%, respectively, during February 2010 from January 2010. 

Market Reaction

The partially convertible rupee weakened 0.35% to close at Rs 45.60 a dollar from previous close of 45.44 a dollar on Friday.

The yield on 10-year benchmark federal paper, 6.35% GS 2020, rose to 8.02% after higher than expected inflation data for February 2010, but eased latter and closed at 7.99% (from 8.01% in the previous trading day), as the investors do not expect any intermittent policy actions from central bank.

The BSE Sensex had declined to as much as 0.6% at 11 a.m., but recovered latter and closed nearly flat at 17164.99. 

Commodity Group wise inflation

Primary Articles (Weight 22.02%)

Within the primary articles, the index for 'Food Articles' group declined by 0.1% to 286.1 (Provisional) from 286.4 (Provisional) for the previous month due to lower prices of tea (9%), arhar (7%), urad (6%), gram, masur and eggs (4% each), fruits & vegetables (2%) and fish-inland, maize, barley and ragi (1% each). However, the prices of fish-marine (5%), poultry chicken (4%), coffee (3%), pork and moong (2% each) and wheat, jowar and milk (1% each) moved up.

The index for 'Non-Food Articles' group rose by 0.1% to 256.5 (Provisional) from 256.3 (Provisional) for the previous month due to higher prices of coir fibre (41%), gingelly seed (9%), mesta (8%), sunflower and Niger seed (4% each), copra, raw jute and fodder (2% each) and groundnut seed (1%). However, the prices of logs & timber (7%), tobacco (4%), skins (raw) (3%), raw cotton and rape & mustard seed (2% each) and linseed and soybean (1% each) declined.

The index for 'Minerals' group rose by 0.8% to 596.3 (Provisional) from 591.6 (Provisional) for the previous month due to higher prices of barytes, iron ore, asbestos and steatite (1% each). However, the prices of magnesite (10%) and felspar (1%) declined.

Fuel, Power, Light & Lubricants (Weight 14.23%)

The index for this major group rose by 1.5% to 356.9 (Provisional) from 351.5 (Provisional) for the previous month due to higher prices of non-coking coal (12%), coking coal (9%), high speed diesel oil and petrol (2% each) and light diesel oil, naphtha and furnace oil (1% each). However, the prices of bitumen (3%) and aviation turbine fuel (1%) declined. 

Manufactured Products (Weight 63.75%)

The index for 'Food Products' group rose by 1.0% to 260.0 (Provisional) from 257.4 (Provisional) for the previous month due to higher prices of khandsari (6%), sugar (5%), bran (all kinds) (2%) and imported edible oil, skimmed milk powder, ghee, gur and salt (1% each). However, the prices of rice bran oil (8%), atta (4 %), oil cakes, cottonseed oil, coconut oil and rape & mustard oil (2% each) declined.

The index for 'Beverages Tobacco & Tobacco Products' group rose by 0.4% to 312.3 (Provisional) from 311.0 (Provisional) for the previous month due to higher prices of soft drinks (all kinds) (3%), potable country liquor (2%) and cigarettes (1%).

The index for 'Textiles' group rose by 0.9% to 154.6 (Provisional) from 153.2 (Provisional) for the previous month due to higher prices of cotton yarn-cones (3%) and Hessian & sacking bags, polyester staple fibre, nylon filament yarn, cotton yarn-hanks, miscellaneous cotton cloth and synthetic yarn (1% each).

The index for 'Leather & Leather Products' group declined by 0.8% to 164.4 (Provisional) from 165.8 (Provisional) for the previous month due to lower prices of footwear western type (1%).

The index for 'Rubber & Plastic Products' group rose by 3.1% to 174.9 (Provisional) from 169.7 (Provisional) for the previous month due to higher prices of plastic items (28%), cycle tubes (9%), cycle tyres (6%), tractor tyres (4%), giant tyres (3%) and pvc fitting & accessories (2%). However, the prices of decorative laminates (1%) declined.

The index for 'Chemicals & Chemical Products' group rose by 0.3% to 231.1 (Provisional) from 230.5 (Provisional) for the previous month due to higher prices of acid (all kinds) (17%), liquid oral other than vitamins (8%), epoxy resins and safety matches (7% each), printing ink (6%), titanium dioxide and polystyrene (5% each), synthetic detergent and benzene (3% each), hair oil, varnishes and p.v.c. resins (2% each) and sulphamethoxozole, bopp film and ayurvedic medicine liquids (1% each). However, the prices of liquid chlorine (17%), soda ash and caustic soda (9% each), methanol (7 %), calcium ammonium nitrate n-content and syrup (6% each), blasting powder (3%) and complex fertilizers-npk content, complex fertilizer n content, antibiotics, oxygen gas in cylinder and carbon black (1% each) declined.

The index for 'Non-Metallic Mineral Products' group rose by 1.4% to 214.9 (Provisional) from 212.0 (Provisional) for the previous month due to higher prices of cement (2%). However, the prices of ceramic tiles (2%) and building bricks (1%) declined.

The index for 'Basic Metals Alloys & Metal Products' group rose by 0.8% to 261.7 (Provisional) from 259.7 (Provisional) for the previous month due to higher prices of aluminium extrusion (15%), aluminium ingots (13%), brass sheets & strips and other aluminium material (7% each), foundry pig iron, basic pig iron and aluminium rolled products (6% each). However, the prices of steel ingots (9%), zinc ingots and lead ingots (7% each), other iron steel (5%) and ms bars & rounds and zinc (3% each) declined.

The index for 'Machinery & Machine Tools' group declined by 0.6% to 172.8 (Provisional) from 173.8 (Provisional) for the previous month due to lower prices of p.v.c. insulated cables (45%), mono block pumps and power capacitors (2% each) and picture tubes (color) (1%). However, the prices of furnaces (17%), switch gears and boilers - its parts & accessories (13% each), other electrical equipment & systems and power looms automatic (5% each), complete tractors and ring spinning & doubling frames (3% each), ceiling fans and enameled copper wires (2% each) and other pumps (1%) moved up.

Progressive scenario 

The all-commodity index increased 3.1% in April-February FY2010, compared to 9.1% growth in corresponding previous year period. The index of primary articles recorded a 10.2% growth in April-February FY2010 compared with a 10.5% rise in April-February FY2009.

In the primary articles, the index of food articles accelerated 14.4% in April-February FY2010 compared with a 8.0% rise in the same period last year. Meanwhile, the index of non-food articles grew 2.9% in April-February FY 2010, compared to 12.4% in the same period last year.

The index of fuel and power shows the fall of 3.7% in April-February 2010 compared with 8.7% growth in the same period last year. 

The manufactured products index has increased 2.8% in April-February FY2010 compared with a 8.7% growth in the same period last year. In manufactured product, the index of food products surged 16.7% in April-February FY2010 compared with a 10.1% increase in the same period last year. 

Sonal Varma expects Inflation rate to hit double digits in March 2010

Sonal Varma, India Economist, Nomura Financial Advisory and Securities said, "India's wholesale price index (WPI) inflation rose a higher-than-expected 9.89% y-o-y in February (Consensus: 9.69%; Nomura: 9.45%) from 8.56% in January, led by fuel and manufactured products inflation. Momentum continues to gather, as reflected in the upward revisions to past data: December inflation was revised to 8.10% y-o-y from 7.31% estimated earlier. Assuming the same rate of upward revisions, the inflation rate likely hit double-digits in February itself, a month earlier than expected by most. 

The primary articles index remained flat over the month as the decline in food articles inflation was offset by increased minerals prices. The fuel index rose 1.5% over the month or 10.2% y-o-y, due to an increase in coal prices and higher petrol and diesel prices after the budget. The bigger surprise was the manufactured index, which rose 0.6% over the month, or 7.4% y-o-y. Recent data had suggested that food product prices, particularly sugar, had declined in February. However, no such decline is reflected in the WPI data. Manufactured prices outside of food continued to move higher across the board, led by beverages, tobacco, textiles, rubber & plastic products, cement, iron & steel and aluminium. The spread and pace of increase has been much higher than we had expected and we judge that past-accumulated adjustments have been made in the February reading.

We expect WPI inflation to rise to double-digits in March as the full impact of the excise duty hikes, the increase in freight costs and adverse base effects are felt. We remain worried about the inflation outlook beyond March as well. Rising input costs and a closing output gap suggest that demand-pull core inflationary pressures are picking up fast. Therefore, even if food inflation tapers off, we expect non-food inflation to remain firm. We expect WPI inflation to average at 7.8% y-o-y in FY11, much higher than consensus expectations of around 6.5%. We believe that WPI inflation will remain in the 8-9% range for most of 2010 (Figure 2). The Reserve Bank of India (RBI) has ruled out an inter-meeting rate move, so we expect the rate hiking cycle to begin at the 20 April policy meeting. We pencil in 150bp of repo and reverse repo rate hikes and 75bp of cash reserve ratio hikes between now and March 2011."

Mridul Saggar expects no monetary policy actions before the scheduled policy date 

Mridul Saggar, Chief Economist, Kotak Securities said, “In our view, RBI is behind the curve as a conscious policy choice in a bid to ensure growth is back. However, the high negative real interest rates now pose risks of (1) adverse impact on private saving and (2) re-building of asset bubbles. With inflation being a lot bigger risk than growth, we expect RBI to go ahead with more monetary tightening, raising policy rates by 50-100 bps on 20 April. India runs the second highest CPI inflation in the world (16.2%), next to Venezuela (27%). It runs the most negative real interest rates (-13%) amongst G-20 countries ahead of UK (-3%). Clearly, RBI looks to be behind the curve and we expect further monetary policy tightening ahead. We, however, continue to expect no monetary policy action before the scheduled policy date of April 20”. 

He said, “We expect RBI to raise its policy rates by 50-100 bps on that date. A further 25-50 bps CRR hike in addition to 50-75 bps policy rate hike is also possible if large surplus liquidity (>Rs650 billion in LAF) remains in the first fortnight of April 2010. LAF surpluses were about Rs 750 billion before the advance tax inflows started temporarily tightening liquidity”. 

“If the current high negative real interest rates remain uncorrected, they could damage economy by (1) adversely affecting private saving that could drop from 31.1% of GDP in FY2009, and (2) re-building asset price bubbles in real estate and commodity sectors. We expect RBI to move in to reduce this probability by further monetary tightening in 1HFY11E by raising policy rates by 150 bps. However, compulsions to support still large government borrowing may force RBI to leave rates below what we deem to be neutral level of about 6.5% nominal or 1.5% real”, Mridul Saggar added. 

Dr Suggar said, “As a base case, we see WPI inflation dropping speedily to 6.7% at end-1HFY11E from 10.4% (about 11% when revised) at end-FY10E. We see inflation dropping at a more moderate pace in 2HFY11E to about 5.8% at end-FY11E. Inflation may thus average about 7% in FY2011E versus 3.8% in FY2010E. Wide probability bands exist to our forecast, as the uncertainty regarding FY2011E is large. A range of 4-7.5% at end-FY11E is possible in our view depending on how monsoon and global commodity prices behave. Food price and supply side inflation is fast becoming general. Manufacturing prices have risen 1.32% over last two months that yields an annualized rate of just under 8%. Pass-through in manufacturing prices would critically determine the full year inflation as well as the policy response even while CPI inflation remains worrisome”. 

Inflation is marginally higher than Deepali Bhargava's expectations

Deepali Bhargava, Economist, ING Vysya Bank said, "It's marginally higher than our expectations. Further confirmation on demand-side inflation edging up is evident again.  Contribution of fuel to inflation is also rising steadily. At the same time, no clear respite from food prices is evident. In such a scenario, WPI inflation is likely to be in double digits in. Our estimates reveal that the impact of fuel price hike in February has been to the tune of 45 bps  (close to our estimates of 50 bps). What's also interesting about fuel inflation is the steadily increasing contribution it's making to WPI inflation since Nov'09.   From -2.9% in Nov'09, it has jumped to 21% of total inflation in Feb'10"

Inflation was above Manjunath Gaddi's expectations

Manjunath Gaddi - Research Analyst, iFAST Financial said, The level of inflation for February 2010 is above our expectations of 9.0% to 9.5%." On the positive said, Gaddi said, "The probability of inflation breaching the record level of 12.8% in the next three months is very low as for such a level of inflation to happen the WPI index levels should increase by 7.31, 11.03, 14.19 points with respect to the February 2010 WPI index level and reach 257.41, 261.32 and 264.09 in the March, April and May months respectively. The highest and second highest increase in the WPI index levels in the past four years on a month on month basis is at 6.3 and 4.7 points respectively and the possibility of having two or three consecutive months with such high level of increases is very low.  So, the inflation can touch double digits but is expected to stay below the August 2008 high of 12.8% 

On the impact of Budget, and the likely spillover effects, Gaddi added, "The Fuel, Power Light & Lubricants sub index of WPI has a weightage of 14.22% and Manufactured products sub index has a weightage of 63.74% in the WPI Index. In February 2010, this Fuel, Power Light & Lubricants sub index rose by 1.5,% the highest among all the three major sub indices on a month on month basis. Since, the budget was presented at the end of February 2010, the inflationary effects of the budget will fully play out in March for the Fuel, Power Light & Lubricants sub index and the spillover effect to the manufactured products could be seen in April and May months.

Summing up, Gaddi said, "With Manufactured products sub index having the highest weightage in the WPI, Inflation numbers for April and May should be keenly watched along with the RBI actions in the Monetary Policy review in April."

Outlook

The inflation for February 2010 was higher than expectations and we expect the inflation to cross double digits in March 2010, factoring in the second level pass through of road freight rates, and as increase in excise duties takes effect for many commodities belatedly. As of now, RBI may not rush with any policy measures before the Annual Monetary Policy Review scheduled on 20th April 2010. 

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