Stuck in the Middle: Rising Food Prices vs Subdued Demand

21 NOVEMBER 2019

Headline inflation jumped more than expected to a 16-month high of 4.6% YoY in Oct19 propelled by higher vegetable prices, even as core CPI continued to decline to 3.5% YoY in Oct19 (vs 4.0% in Sep19). Despite a 260bps jump in the headline inflation since Jan19, CPI ex-vegetables has remained in the 2.9-3.2% range.

Food & Bev CPI rose 2.2ppt month-on-month to reach 6.9% YoY in Oct19 (highest since mid-2016), led by a spike in vegetable prices (up 26% YoY vs 16% in Sep19). As opposed to last month however, the increase in vegetable prices was more broad-based in Oct19, with ex-onion & garlic inflation rising to ~13.0% YoY (vs 6.0% in Sep19 and 5.5% in Aug19).

Source: CSO, CEIC, Citi Research

Vegetable prices tend to spike towards the end-monsoon season before reverting to trend, as fresh supplies start coming in from November. This reversion may get delayed this year due to unseasonal rains and floods, however Citi analysts expect some price reversal by 4QFY20, resulting in a 100-120bps moderation in headline CPI over a 6-month horizon.

Citi analysts expect 3QFY20 CPI to average at ~4.7% YoY and revise their FY20 forecast to 3.8% YoY (up 0.4ppt). Increase in food prices, combined with Government led income support schemes, may provide some support to rural demand.

Citi analysts believe that the spike in Food CPI in a demand-constrained economy may complicate policy response from the RBI. They expect the RBI to turn more cautious in the Dec19 MPC review, while still expecting a 25bps cut in the repo rate. The extent of further rate cuts, however, remains uncertain.

Citi analysts expect easy monetary policy and the risk of fiscal slippage to keep bond yields range bound, with the 10-yr Gsec yields targeted at 6.5% over the near term.

Fixed Income investors may continue to focus on high credit quality with a preference for short duration and remain diversified in their portfolios. For more details and implications for your portfolio, please contact your relationship manager.

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