India Insight:CPI inflation close to two-year low

Headline CPI inflation decelerates further to 3.4% YoY in Dec: Thiscompares with 3.6% YoY registered in the previous month. This was lowerthan the market expectation of 3.5% YoY. Core inflation, on the other hand,remained largely stable at 4.9% YoY in Dec vs the previous month.

    Demonetization move partly resulted in slowing inflation momentum:The cash shortage in the wake of demonetization adversely impacted thetransportation, distribution and sale of perishable items in the wholesalemarket, as these transactions are highly cash-dependent. This resulted infarmers selling perishable items (especially vegetables, etc.) at much lowerprices than required. At the same time, the slowdown in economic activity alsoresulted in reducing the demand-side pressures.

    CPI inflation to remain manageable: We expect CPI inflation to average~4.5% YoY in the Mar-17 quarter (about 50bp below the RBI’s target of 5%)and average 4.6% in FY18. The temporary slowdown in economic activityexpected post demonetisation, a bumper summer crop, good progress in thesowing of winter crops (up 6.5% YoY as of the week ended 6 Jan) and activefood management by the government will likely keep inflationary pressurescontained over the next few months. However, we need to watch for upwardrevisions in MSPs (minimum support prices), a rise in rural wages (+8% YoYin Oct-16) and a rally in global crude oil prices (up 20% since Nov-16), whichcould result in upside risks to CPI inflation forecasts in FY18.

    Scope of further policy easing remains: RBI has reduced the repo rate by175bp this cycle (since Jan-15). The transmission to lending rates based onMCLR has picked up, especially post demonetization, and has been to thetune of ~175