Sub-4% core inflation betrays weak demand conditions

The Reserve Bank of India has kept the policy repo rate unchanged since February 2022 at 6.50%.

The Reserve Bank of India’s (RBI) monetary policy action may be credited for reducing core Consumer Price Index (CPI) inflation in the recent months, but a sub-4% core print also denotes weak demand conditions in the country at an aggregate level, say economists.

Curiously, this is also a bit at odds with the RBI’s assesment in its November bulletin that “investment demand appears to be resilient given the government’s infrastructure spending, an uptick in private capex and digitalisation.” Concerns were even expressed by the central bank about another possible spell of demand pull inflation.

Data released on Friday showed core CPI inflation fell to a 48-month low of 3.9% in December from 4.1% in November, while CPI inflation rose to a four month high of 5.69% from 5.55%.

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“While India’s tight monetary policy action can be credited for weakening core inflation, we also see clear signs of persistence of household stress too playing its part,” said Kunal Kundu, India economist, Societe Generale.

The Reserve Bank of India has kept the policy repo rate unchanged since February 2022 at 6.50%. In the December monetary policy meet, RBI had said that core disinflation has been “steady”, indicative of the impact of past monetary policy actions.

ICICI Bank said that lower core inflation is explained by decline in global commodity and energy prices and the resultant pass-through into the economy along with “muted consumption”.

Weaker demand could also be gauged by tepid growth in consumer durables (goods directly used by consumers having long durability of two-three years) output – which in the first eight months of FY24 has grown merely 0.8% y-o-y as against 8.9% growth recorded in the comparable period of FY23. In November, the production growth of consumer durables stood at a five month low of (-)5.4%.

Moreover, the private final consumption expenditure (PFCE) is expected to grow at 4.4% y-o-y in FY24 – as per National Statistical Office’s first advance estimates – which is the slowest pace in the current series that started in 2011-12. This excludes the pandemic year FY21, where PFCE had contracted 5.2%.

High frequency demand indicators reflect bleaker conditions in rural areas as against urban ones. Interestingly, this situation stands amidst higher-than-expected GDP growth projection of 7.3% in the current fiscal.

Commonly, economists assert that elevated economic growth results in increased demand, subsequently leading to higher core inflation. However, the existing state of the core CPI has left some economists bewildered.

“Declining core inflation at a time of strong economic growth is a conundrum,” said Sunil Sinha, principal economist, India Ratings and Research.

But this was answered to some extent by Ashima Goyal, external member, RBI’s Monetary Policy Committee, who said that there were no second round effects raising wages from the earlier commodity price shocks since Indian labour markets are “slack”.

As per the Periodic Labour Force Survey, the growth in earnings of regular workers in Q1 FY24 rose to 7.8% from 6.1% in the previous year. But for casual workers, the growth in earnings dropped sharply to 5.2% from 17.1% during the period.

Goyal also said that some firms have reversed earlier price increases that passed on higher costs, and government supply-side actions have moderated short term price spikes. Also, Indian oil majors are in a position to pass on the benefits of lower oil prices to consumers.

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“All this continues to reduce costs for firms. In these circumstances, core inflation should continue to converge towards 4% and headline should converge to a stable core despite any further transient supply shocks,” Goyal explained.

Going forward, economists expect core inflation to remain subdued but slightly above the current levels.

“Weak momentum in core inflation and subdued core services inflation suggests fall is sustainable, although there could be data quality issues with housing part of CPI that should reverse next fiscal,” said Abhishek Upadhyay, senior economist, ICICI Securities Primary Dealership. He sees core CPI averaging 4.5% in FY25 – at similar levels to FY24.