INFLATion

Inflation in Jan declined markedly to ~6.6% YoY from ~7.5% in Dec, reflecting not just high base effec t but receding price pressures as well. Adjusting for seasonality and base effect (MoM SA, 3MMA), th e data illustrates an apparent moderation in manufacturing inflation in recent months. Indeed, our r earranged WPI basket also shows that the demand driven inflation has eased substantially, reaching its historical average. Meanwhile, the imported inflation has also lessened somewhat, but still remai ns elevated steered by fluctuations in INR and commodity prices. In the coming months, we see th e headline inflation hovering at current levels. The primary articles inflation is likely to normalize to 6 %7% in coming months from unusually low levels at present. This rise, however, will be negated by a further decline in core inflation amidst falling demand pressures and high base effect. As regards m onetary policy, such a trend of easing price pressures should give the RBI confidence to move further on its path of reversing the monetary cycle. Therefore, given the tight liquidity deficit conditions, we expect another CRR cut by the central bank in March though as of now, a repo rate cut remains a clo se call with the RBI keenly watching the incoming data, particularly Q3 GDP, to assess the deteriorati on in the growth momentum. Inflation shows a real decline Inflation for the month of Jan declined to ~6.6% YoY (~7.5% in Dec) the lowest in 26 months, but a tad lower than our expectation of ~6.7% (YoY). The fall in inflation was mainly due to a broadbased decline in manufacturing inflation and a h igh base effect. Moreover, primary inflation (both food and nonfood articles) fell further to 2.3% fr om an already depressed level of 3.1%, largely on account of a strong base effect. Major highlight of the inflation data was a healthy decline in the seasonally adjusted sequential tren d (which strips out the base effect) of manufacturing inflation. Moreover, as per our rearranged WP I basket, this decline was seen in both demand driven and imported inflation components. Both tren ds are a significant postive as they reflect that: a) price pressures are receding in the economy in real sense (rather than just on statistical base effec t) reflecting slowing demand and b) the effect of INR depreciation responsible for sustaining the imported inflation at elevated levels in the past is abating. In the coming months, in addition to above trends, a strong base effect will ke ep manufacturing inflation on a declining trajectory. However, the fall in primary inflation to unusu ally low levels in the last few months may normalise to ~6%7% YoY as the base effect wanes in the next couple of months. Overall, the headline inflaiton is expected to remain in the current range in c oming months.

Source: Office of Economic Advisor, CMIE, Edelweiss research Agro inflation likely to rise in Feb In p rimary articles, inflation fell further to abnormally low levels of ~2.3% YoY from an already low level of ~3.1% YoY in December, reflecting a very strong base effect. Among components, food inflation c ontracted by ~0.5% YoY in Jan versus a growth of ~0.7% in Dec while nonfood inflation fell to ~0.6% YoY versus ~1.5% in December. However, as base effect tapers off in the coming couple of months, i nflation in primary articles, especially food articles, is likely to normalise to ~6% to 7% (YoY). Core inf lation declines on falling demand, imported inflation Core inflation (nonfood manufacturing) decline d meaningfully to ~6.7% YoY in Jan versus ~7.7% in December. On a sequential basis (3MMA SA), ma

nufacturing inflation eased to ~0.3% compared to 0.6% in the previous month, suggesting that a fall in YoY inflation is not entirely due to high base. This is also evident from our rearranged WPI basket (which divides inflation into agrobased, imported and demand driven) which shows a fall in importe d (~15.5% YoY in Jan vs ~16.1% in Dec) as well as demand driven inflation (~4.2% YoY in Jan vs ~5.0% in Dec)

Edelweiss Securities Limited InflationIndeed, as per our analysis, the demand driven inflation is now quite close its long term average meaning that the monetary tightening has been quite succesful in c ontrolling demand pressures in the economy. In the coming months as the economy slows down further as lagged impact of past tightening plays out demand pressures would continue to ease hence core inflation should decline further. However, a recent rise in global commodity prices (despite a signfic ant appreciation in INR) would limit the extent of a fall in core inflation. Chart 2: Demand driven inflation on a declining trend Source: CMIE, Edelweiss research Fuel inflatio n declines marginally Fuel and power inflation declined marginally to ~14.2% YoY in Jan compared to ~14.9% YoY in Dec on base effect. We expect this inflation to remain elevated in the coming months as oil prices remain high despite a fall in global growth expectations. Moreover, the recent esclation in geopolitical tensions poses significant risks. In addition to oil prices, price pressure in this segmen t is also likely from electricity prices as state electricity boards are in the process of raising tariffs. Expect inflation to remain at current levels In the coming months, headline inflation is expected to s tay around the same level as a fall in manufacturing inflation (due to lowering demand pressures and base effect) would be negated by a rise in primary article inflation. Moreover, a rise in global comm odity prices (despite appreciating INR) is expected to limit the fall in manufacturing inflation. In ter ms of the monetary policy, the economy is already facing tight monetary conditions which are gettin g aggravated by a persistently high liquidity deficit ( presently at ~INR1.30trn vs RBIs target range of ~INR0.6trn). As inflation is on a declining trend, RBI has indicated its willingness to support growth in policy meetings. Accordingly, the central bank is expected to undertake a CRR cut of 50 bps in the n ext policy meeting to ease liquidity deficit. However, a repo rate cut still remains a close call because even as inflation pressures are receding, RBI is keenly awaiting Q3 GDP growth data (to be released on 29th Feb) to judge the direction of growth deterioration.