Edelweiss Broking Limited - Research Report - Economic Spotlight: Core Inflation - RBI's Logical Target

Highlights

·      Headline CPI declined by 3.5% between FY14 and FY15. The disinflation could be majorly attributed to fall in food prices aided by low fuel prices.

·      Fuel prices did not have major role in disinflation due to excise duty hikes by government limiting pass through of low oil prices to consumer.

·      There are lesser fluctuations in the prices of components of core inflation than in food and fuel prices. Food and fuel prices are directly linked to global prices leading to higher volatility.

·      Inflationary expectations have been very high in India. A vicious circle of high the vicious cycle of high inflation to high inflationary expectation to higher wage expectations to higher inflation. RBI plays an important role in anchoring inflation expectations.

·      Healthcare costs and education costs have been dramatically rising increasing the cost burden on the households. Privatization in both the sectors has pushed up the prices. Increasing government expenditure on welfare sector could play a major role in rationalizing the prices

·      Housing Prices have been rising at a slower pace as compared to the peak in FY11/12. Regulatory overhaul to increase transparency and demonetization drive are key for the real estate.

·      RBI ‘Neutral’ stance keeping Core Inflation in focus seems prudent. Most of stickiness in core is structural in nature apart from inflationary expectations. A neutral stance will enable the central bank to anchor inflationary expectations better.

·      We believe this would help in stabilizing the bond markets after wild gyrations seen in the last four months. RBI may choose to stand pat and see through the effect of the loose monetary policy which it practiced over the last 2 years. This sends a signal that inflation remains a key pillar of stability for Indian economy.