WPI – The fall has been arrested

Sep'15 WPI deflation was -4.54%, an increase from the largest fall (of -4.95%) the month prior. We had expected a stronger pull-back; however, the aggravated deflation in fuel negated the impact of the small increase in food and manufactured products. The index tends to fall in H2, which, if happens, might result in continuing WPI deflation for the rest of FY16. Rate cut will driven by CPI inflation trajectory, and if the CPI is in line with the RBI inflation target, another 50- to 75-bp rate cut in 2016 is possible.

Performance. The Sep'15 WPI deflation was -4.54% (-4.95% in Aug'15). Manufactured-product deflation increased slightly and was -1.7% (vs. -1.9%). Food inflation turned positive, 0.2%, after being negative for the past two months. Deflation in fuel & power was -17.7% (vs. -16.5%). Core, which has been in deflation for past ten months, increased to -2.9% (vs. -3.2%). Similar tre nds were seen in non-core deflation, which lost some pace and was -6.3% (vs. -6.9% the month prior). Ytd deflation was -3.4%, within which the fuel and & power component is in a -12.8% deflation.

Assessment. The trend in WPI has been downward for more than a year and has been in the negative for the eleventh month in a row. The broad index has fallen for a third straight month. After having fallen in the past three months, the manufactured product index rose in Sep'15. Basic metals and chemical products continued to be in deflation. The Indian basket of crude-oil prices has slipped in the past four months, mirroring the sharp deflation in fuel during Jun-Sep. Pulses inflation is nearing 40%, and has been galloping ahead for the past ten months. Onion inflation is also up.

Outlook. The trajectory of fuel inflation would depend on crude-oil prices. The continuous decline in the decline would keep fuel in deflation in the medium term. Food inflation is likely to move up as the impact of favorable base has been depleted. Despite the deficient monsoon rainfall, the initial estimates of the kharif crop show that production has increased from the past year. The surplus global capacity, the slowdown in global recovery, will make the capex cycle prolonged. With steep deflation in H1 and the trend of the index to fall in H2, chances of the WPI being negative for all of FY16 have risen.

Recommendations. Governor Rajan had once again surprised the market with a 50-bp rate cut, against the consensus 25-bp cut expected. The RBI now expects inflation to fall to 5.8% in Jan'16 and 4.8% in Jan-Mar'17. We see inflation hardening significantly in the next two quarters from levels now, but still holding below 6%. The upside to inflation has been contained. Our estimate for CPI inflation for FY16 is 4.8% and we expect inflation to be around 5% in 2016. If this downshift plays out, there is room for another 50- to 75-bp rate cut in 2016.

by Mr. Sujan Hajra(Chief Economist- AnandRathi Institutional Research)