Inflation stays benign. The September CPI inflation print at 3.28% has ensured that inflation stays in a range of 3.3%-4.4% for 2HFY18, lower than RBI's estimate of 4.2%-4.6%. However, with inflation trending up directionally and RBI's insistence on 4% target on a durable basis, a convincing case for a rate cut appears less plausible. But we will be watchful of any incoming data surprises and evolution of the fiscal stance for any meaningful shift in RBI's reaction function.
CPI inflation surprises at 3.28%
CPI inflation surprised on the downside at 3.28% in September (Kotak: 3.37%, consensus: 3.53%) after a downwardly revised 3.28% in August. Sharp contraction in food inflation ((-)1.4% mom) countered the unfavorable base effect and sequential increase in housing and fuel prices. Food inflation eased to 1.2% from 1.5% in August with sequential contraction in vegetables ((-)7.1%) and fruits ((-)1.6%) prices. High frequency mandi data indicates marginal seasonal uptick in cereals and vegetables prices ahead. Core inflation inched up to 4.4% from downwardly revised 4.3% in August with 'miscellaneous' items inflation remaining stable at 3.8%. Within 'miscellaneous' segment, 'personal care and effects' category increased substantially to 2.9%, partly reflecting the changes in the GST rates. 'Transport and communication' category increased 0.9% mom due to higher petrol and diesel prices. Housing inflation was at 6.1% reflecting consistent sequential increase due to 7CPC HRA impact.
Inflation set to trend up, but likely to still stay lower than RBI's estimates
Despite food inflation looking mostly comfortable, the unfavorable base effect and 7CPC HRA increases will pressurize headline inflation to inch up from November onwards. We see headline CPI inflation accelerating to 4%+ by December and remain around 4.3% average in 4QFY18. Core inflation is also likely to trend up to 4.5% in 2HFY18, as against 4.1% in 1HFY18. However, the overall average still looks benign at 3.3% and 4.3% for headline and core inflation respectively. This excludes states' 7CPC HRA implementation, which, when implemented, will push up headline inflation by around 85 bps on an average.
IIP growth rebounds in August
IIP growth accelerated sharply to 4.3% in August after 0.9% in July (Kotak: 3.37%), partly reflecting some payback in production as manufacturers begin adjusting to GST. Among the top positive contributors were 'meters', 'separators', 'digestive enzymes and antacids', etc. while top negative contributors were 'anti-malarial drug', 'gold jewelry', etc. Manufacturing sector increased 3.1%, owing to strong rebound in capital goods (5.4%) and consumer non-durables (6.9%). Mining growth was at 9.4% on the back of 15.3% coal production growth.
Rate-cut cycle seems to be over for now, but incoming data surprises remain key
Even as we see (1) CPI inflation averaging around 3.3% in FY2018 (including central 7CPC HRA) and (2) March 2018 inflation slightly below the upper end of RBI's 2HFY18 range of 4.2-4.6%, we reckon that directionally inflation will be trending higher. Core inflation, too, will likely stay sticky around 4.5% mark. With RBI fixated on the 4% target on a durable basis, and with plausible case of fiscal slippage, it looks less convincing for a policy easing in the near term, unless data surprises on the downside significantly. In this context, we will continue to monitor the evolution of (1) crop production, (2) downward surprise of core inflation owing to weaker-than-expected growth, (3) second-round impact of lower excise duty on petrol and diesel and (4) status of government's accounts.