India rates: Inflation lull unlikely to last

Inflation to quicken in October
Radhika Rao11 Nov 2021
    Photo credit: Unsplash Photo

    INR short-term yields have remained firm in recent sessions, with the 10Y yield (generic) likely to prod north today after the overnight jump in USTs and high oil, notwithstanding encouraging local developments. Providing some relief to inflation was the government’s move to cut fuel excise duties last week, which effectively lowered prevailing pump prices by 4.5-10%. The central government’s moves were also complemented by few states’ who lowered their local taxes. Our analysis shows that this move will translate into potential miss in fiscal revenues to the tune of 0.2% of GDP for rest of the year, 15-20bps softening in inflation and lower pressure on disposable incomes/purchasing power, boding well for consumption. We are, however, mindful that further increase in global crude prices might trim net benefits from lower taxes, necessitating the authorities to keep an ear close to the ground and provide further relief if required. 

    Notwithstanding the fiscal impact, the year-to-date buffer from tax and non-tax revenues increases the likelihood that the FY22 deficit might still be 20-30bps narrower than our forecast of -6.8% of GDP. The reduction in fuel tax meets one of the demands of the monetary policy committee. Add to this, administrative measures like cuts in import taxes on edible oils, boosting stocks of perishables (vegetables etc.) have also been undertaken to keep a lid on price pressures, even as commercial LPG prices were revised up. Friday’s inflation release is likely to see October CPI inflation quicken anew (see our preview). Even as average CPI slips into the RBI’s target range in 4Q21, owing to base effects, inflation is set to firm up late-2021 and extend its rise in 1Q22 on a narrowing output gap, simmering food, passthrough of higher input prices and imported prices pressures.

    Radhika Rao

    Senior Economist – Eurozone, India, Indonesia
    [email protected]

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