Macro-economic forecasts and analysis
Real-time analysis of data releases and copious indicator data
Consumer price inflation increased to 4.87 per cent in May 2018 compared to 4.58 per cent in April. Prices of consumer goods and services in May were 0.5 per cent higher than they were in April 2018. Compared to year-ago levels and also month-ago levels, price indices have been rising steadily each month, in the past few months. There is an acceleration in inflation.
An increase in inflation in May was expected largely because of the sudden increase in crude oil prices in the month and its expected impact on petroleum product prices in India. But, petroleum products have a small weight and more importantly, the increase in crude prices was short-lived. These peaked at USD 78.1 per barrel on May 22 and then declined to USD 73.5 per barrel by June 5. Finally, the average price in May was USD 75 per barrel compared to USD 69.3 per barrel in April implying an increase of 8.2 per cent. The increase in April was slightly higher at 8.5 per cent.
The increase in prices of petroleum products was much lower. Compared to the earlier month, the price of petrol in May was up by 2.1 per cent, diesel was 3 per cent higher and kerosene was 2 per cent higher. The price of LPG was 0.5 per cent lower, according to the CPI data.
The impact of crude oil price increases in May is therefore not proportionately reflected in the price indices of petrol, diesel, kerosene or LPG. To a great extent this reflects the fact that prices were kept unchanged till May 13 when the Karnataka state elections concluded. Petroleum product prices rose sharply thereafter but were reduced towards the end of the month as the ascent of crude oil prices had stopped.
The increase in crude oil prices is no longer expected to play a very large role in determining inflation. The larger role is that of house rent allowances.
Compared to a year-ago level, among the broad components of the CPI, it was housing that saw the largest increase - of 8.4 per cent in May. However, this is essentially a base effect since compared to the previous month, the housing index saw the smallest increase (of 0.2 per cent) compared to all other broad components of the CPI. Interestingly, the index for fuel & light also saw a very modest 0.29 per cent growth in May compared to its level a month ago.
Core inflation (which is inflation in goods and services excluding food group and fuel and light group) is much higher than non-core inflation. While overall (headline) inflation in May 2018 was 4.87 per cent, core inflation was 5.95 per cent and non-core inflation was 3.49 per cent.
The sustained increase in core inflation over the past year - since June 2017 is perhaps, one of the main reasons why RBI chose to raise interest rates on June 6. But, the rise in core inflation is perplexing. Sustained low food prices are expected to lead to a fall in core inflation. But this not seen in the data. This is partly explained by the rising HRA in core inflation.
The sustained increase in core inflation and its elevated level compared to headline inflation raises a question whether high inflation expectations among households have been feeding into wage pressures which keep inputs costs high which in turn keeps core inflation high.
Inflation expectations, according to RBI’s survey, have remained consistently high. This is in spite of the significant and sustained fall in food inflation which, according to received wisdom should have led to lower inflation expectations.
According to RBI’s survey, the median expectation of inflation three months ahead was 8.7 per cent and for inflation 12 months ahead it was 9.9 per cent. These are very high rates of inflation compared to the current trend of sub-5 per cent.
But, a caveat is in place here. These expectations should be compared to the perception on inflation. Households perception of inflation is also very high. The same RBI survey shows that households perceive current inflation to be 7.9 per cent (median value).
RBI has raised its own expectation of inflation in 2018-19. It has changed its expectation of inflation in the first half of the year from 4.7-5.1 per cent earlier to 4.8-4.9 per cent. Its projection for the second half is raised from 4.4 per cent to 4.7 per cent. An increase in core inflation in April and May “suggesting a hardening of underlying inflationary pressures”, a surge in crude oil prices and an increase in input costs influenced this change.
We agree with the RBI’s projections and reduce our own expectations of inflation in 2018-19, which was set at 5 per cent.