India CPI – not just imputation and supply constraints
The headline Consumer Price Index (CPI) for June 2020, higher than consensus expectations, was at 6.1% year-on-year, after 7.2% in April and 6.3% in May. The numbers are impacted by the imputation methodology used in April-May (in the absence of full component-level data during the lockdown and immediately after) and seemingly due to the impact of a more adverse supply-shock. However, a closer look implies actual buoyant core readings (headline CPI excluding food & beverages, fuel & light)in June which almost entirely emanate from rural India. This divergence between rural and urban data suggests this could not be just production-linked supply-side constraints, but has an element of higher rural demand likely driven by good seasonal agricultural activity and government spending there. However, the sustenance of this could be challenged, particularly after the Kharif season, due to labour dynamics and the real magnitude of the overall hit on demand from Covid-19 would become more visible then. For monetary policy, this means even if the RBI Monetary Policy Committee (MPC) pauses in August, it doesn’t imply a halt in its easing cycle given softer expected medium-term inflation trajectory and overarching growth concerns, even if the RBI MPC’s decision may not be as clear-cut in the very near term.
Rural drives higher core inflation in June, after imputation methodology in April-May
Looking at the sequential month-on-month (m/m) momentum to better understand the price movements from April to June, we see:
– Food and beverages picked up again in June (lead by vegetables, milk and prepared meals) after it eased a bit in May, following a sharp pick up in April owing to the lockdown. Some of this increase now, particularly in vegetables, is seasonal.
– Both headline and core inflation in April and May were higher mainly because the former was compiled using only available data, essentially food prices which moved higher, and the latter then imputed from the headline index as actual data was not collected. June is the first month after March in which all the component-indices have been calculated using actual data.
– Focusing on the June numbers, we see the sequential momentum in core inflation was positive (0.24%) in June. This confirms core inflation now is actually higher than expected and is not just higher due to the imputation in April-May. Else, the sequential momentum in price-levels of core components would have corrected/contracted in June after the imputation-induced spike.
– More importantly, the June momentum in rural inflation is much higher than in urban (except for fuel). This is particularly so for the core components (pan & tobacco, clothing & footwear, education, personal care & effects, transport & communication and recreation & amusement).
Lower supply or higher demand?
– One school of thought reckons the higher core inflation in June stemmed from higher-than-expected supply side constraints and pricing power. However, if this was the primary reason, wouldn’t supply constraints result in both higher rural and urban inflation? Given it was urban areas which were at higher (although at varying) levels of lockdown in June, it could be argued any supply-constraint in delivering goods and services would have been higher there. This would have then caused higher inflation in urban, and not in rural, India as seen now (ceteris paribus).
– Any supply-constraint in production (sourcing and movement of raw materials, labour, etc.) should impact rural and urban equally as it is unlikely to have a production constraint only for one segment.
– More likely, it appears from the June data that rural demand was quite higher than urban, more so given the sequential momentum was much higher in almost all the core components and the fact that the divergence was not as high in the food basket. These core-categories include several non-food daily-use household essential goods and services, petrol, mobile phone charges, bus fare, medicines, etc. (apart from items like pan & tobacco and gold, prices of both of which have also increased).
– Also, other high frequency indicators point to a likely higher demand from rural India (e.g. strong rabi season wheat procurement, strong kharif season sowing progress alongside a good monsoon and reservoir levels, high government rural spending, Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) support for wages, etc.). If urban demand was meaningfully strong, it would have partially offset the low CPI momentum, at least in some of the non-food items.
– From a medium-term and policy perspective, the key question is whether this buoyant rural demand growth is sustainable? Rural jobs and wages now could appear better owing to the strong Kharif season sowing in progress for almost all crops, alongside a good monsoon and high reservoir levels, and that too after a record wheat procurement during the rabi season. However, the surplus rural labour from reverse-migration and the weak construction sector activity not supporting wage growth don’t augur well for a sustained rise or maintenance of rural wages and therefore demand. This could also impact workers’ preference to stay back in rural or migrate back to urban areas. The higher wage earners and/or the ones preferring non-agriculture work could be more inclined to migrate back to urban areas once heath-risks there are perceived to be much lesser then before. All this could make the real hit to demand more visible then.
Not a deterrent for the RBI’s easing cycle on a forward looking basis
Firstly, a persistently higher rural demand could make the Gross Domestic Product (GDP) deflator higher than expected, but this is unlikely to meaningfully materialise given the above factors. For monetary policy, the April and May headline numbers could essentially be seen as compiled only from food prices and the government’s CPI press release clearly mentions it is only for business continuity purposes. Even if the MPC chooses to pause at the August meeting, it doesn’t mean there is no additional easing ahead. Although headline inflation could hover near the upper end of the RBI’s target band in the next few months (please note it continues to be very difficult to forecast monthly CPI given detailed component-indices are not available from March till June), its trajectory is still most likely to shift downward thereafter, with Kharif harvest arrivals and strong base effect coming into play. Also, any higher rural demand now awaits a sustenance test which would be challenging given the likely labour and wage dynamics. Most importantly, for the MPC, the growth concerns should still far outweigh the inflation worries implying lower-for-longer policy rates.
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