WPI Inflation - Rate hike a fait accompli - Anand Rathi

After the unexpectedly high CPI inflation in Nov'13 (11.2%), WPI inflation during the month, at 7.5%, was much ahead of estimates. Food and fuel contributed 70% to the inflation, while manufactured product prices remained largely benign. The high realized and latent inflation would compel the RBI to hike rates by 25bps in Dec'13.

Performance. WPI inflation during Nov'13, at 7.5%, was much higher than expectation (7.1%) and last month's level (7.0%). As compared to the previous month, while inflation has gone up for all main categories, the rise is particularly marked for primary (from 14.7% in Oct'13 to 15.9% in Nov'13) and fuel & power (from 10.3% to 11.1%). The rise in manufactured product prices (from 2.5% to 2.6%) has, however, been relatively modest. Rising food prices is the major reason for the unexpected jump in WPI inflation. In Nov'13, food inflation, at 19.3%, is at record high. Vegetable and onion inflation in Nov'13 were at 95.3% and 190.3%, respectively. High revesion of past data further adds to uncertainties.

Assessment. After the surprise jump of CPI inflation in Nov'13, WPI inflation also posed a major unpleasant surprise. Interestingly, non-food and core inflation in Nov'13, at 5.1% and 3.3% respectively, remained subdued. Sustained increase in minimum support prices have increased the prices of food crops (rice inflation in Nov'13 at 15%) and on the other hand put pressure on acreage under non-food crops including vegetables. This, in turn, pushed up non-food crop edible prices. Various supply disruptions in the recent past have also contributed to high food inflation.

Outlook. In contrast to the jump in manufactured product inflation last month, food inflation led to the sharp jump in both WPI and CPI in Nov'13. The general expectation of the softening of food inflation from Nov'13 has come unstuck. While the CPI numbers suggest that the food inflation is getting transmitted into services inflation as well, there is no such indication in the manufacturing sector as yet. Yet, rise in non-core inflation eventually gets transmitted into core inflation. In addition, the pass-through of rupee depreciation has raised prices of imported input prices. Even if the food inflation starts abating, latent inflation on account of pass-through of high food prices (and therefore wages) and input cost pressures on account of rupee depreciation would remain large risks to the inflation outlook.

Recommendation. The surprise jump in both CPI and WPI inflation during Nov'13 has virtually closed the RBI's option of not raising the policy rates. We expect 25bps rate hike in the Dec'13 monetary policy review. Unless inflation abates considerably in the next 1-2 months, another 25bps rate hike in 4QFY14 looks likely. Expectation of a rate hike is already impacting the debt, foreign exchange and equity markets (particularly interest sensitive segments). Therefore, the major impact of 25bps rate hike is largely priced in. A larger-than-expected hike would, however, negatively impact all these markets.

Source : Equity Bulls

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