India continues its battle with inflation

WPI headline inflation eases but remains high at 9.11%YoY in November: The headline inflation rate eased to 9.11%YoY in November, compared to 9.73%YoY in October 2011.

The seasonally adjusted WPI index was up 0.5%MoM in November vs. 0.7%MoM in October, based on provisional data. The headline inflation in November was in-line with our expectation of 9.1-9.4% but slightly higher than consensus expectations, as per Bloomberg’s survey, of 9.02%. The final inflation for September 2011 was revised higher to 10%YoY from 9.72%YoY reported earlier.

Non-food manufactured inflation rose slightly in November: Non-food manufactured inflation that the Central Bank monitors rose slightly to 7.9%YoY in November (7.6%YoY in the previous month). The items, which continue to add pressure to non-food manufactured inflation, are basic metals alloys and metal products (1.5%MoM), non-metallic mineral products (0.9%), and beverages, tobacco and tobacco products (0.6%).

Fuel inflation accelerated to 15.5%YoY in November compared to 14.8%YoY in October driven by higher prices of the decontrolled component in mineral fuel group and electricity. Within mineral fuel group, prices rose for ATF, furnace oil and naphtha (6%MoM each), bitumen and petrol (1% each) while it declined for light diesel oil (-1%).

Food inflation moderated: Food inflation moderated to 8.1%YoY in November as compared to 9.9%YoY in the previous month. Primary food inflation declined sharply to 8.5%YoY vs. 11.1%YoY in October and manufactured food inflation softened to 6.8%YoY vs. 7.8%YoY in previous month.

Within primary food articles group, prices eased the most for fruit and vegetables (-7%MoM), poultry chicken (-6%) and fish-inland and moong (-4% each) amongst others and within manufactured food products group, prices softened the most for gur (-9%MoM), tea leaf-blended (-8%) and tea leaf-unblended (-5%).

Inflation remains a challenge: Headline inflation has remained above the RBI’s comfort zone of 5-5.5% for the past 24 months averaging 9.5% during this period. Assuming global commodity prices remain range bound, we maintain our view that the headline WPI inflation will moderate to around 7-7.5% in March 2012. However, we see upside risk to this number from the weakening rupee.

What about policy response and growth outlook? We expect RBI to keep the repo and reverse repo rate unchanged on December 16, in-line with its guidance provided in the monetary policy meeting on October 25. Since the last meeting, WPI inflation has been as per expected trajectory and global commodity prices have also been range-bound warranting RBI to maintain its guidance. However, given the persistence of stress in inter-bank liquidity, particularly since November, we see a 60% probability of cash reserve ratio cut of 50bps.

A combination of high and persistent inflation, the slow pace of policy reforms to boost investment, graft-related investigations, weak global capital markets and a weak global economy have begun to weigh on India’s growth trend. We are increasingly concerned about the duration of the growth slowdown. As we have been highlighting, a weaker growth trend lasting for more than 3-4 quarters could make the cycle more harmful, with a major rise in non-performing weaker assets leading to risk aversion in the domestic banking sector.