Global Reflation Fears: Does India Need To Worry?
With governments and central banks continuing to add stimulus to support their respective economies, global markets have started to price in reflation. Commodity prices are rising and so are bond yields, on fears that inflation could make a stronger-than-anticipated comeback.
Does India have cause to worry amid these rising global commodity prices? Yes and no, said economists pointing to the fractured correlation between global and local price trends. While some wholesale prices may be impacted by rising global commodity prices, retail inflation - dominated by food items - may remain in check in India, they said.
On Feb. 22, 2021, the spot Commodity Research Bureau index — a basket of commodities traded in the U.S. — rose to its highest since September 2014. It is up 22% from a year ago and about 40% from the lows hit in April 2020.
“The link between domestic and global inflation is a bit like milk on a stove — as long as the flame is low, there’s little to worry about,” said Aurodeep Nandi, India economist at Nomura. “But turn the heat up and it can rapidly boil over.”
Nandi said commodities play an outsized role in driving core inflation in India, adding that when the flare-up comes in tandem with strong domestic recovery, manufacturers have a greater propensity to pass on the higher costs to consumers.
Suvodeep Rakshit, senior economist at Kotak Institutional Equities, shares that view.
CPI inflation being dominated by food prices sees a much more muted impact from global commodity prices than WPI. However, core CPI inflation will see some upside given firms could see some pressure from raw material prices which will feed into output prices.Suvodeep Rakshit, Senior Economist, Kotak Institional Equities.
Higher Oil Prices: Direct And Indirect Impact
Global crude oil prices are always the first point of impact for local inflation, since India imports most of its fuel need. The Indian crude oil basket moves in tandem with Brent crude oil prices.
A research note by BofA Securities dated Feb. 23, 2021 estimates that a 10% change in oil price will impact CPI inflation by 23 basis points directly. The indirect impact, tougher to compute, plays out via higher transportation costs and prices of items where crude oil is used as a raw material. Indranil Sen Gupta, India economist at BofA Securities, estimates the indirect impact at 100 basis points over time.
These higher oil prices hurt consumption when the economy is recovering, the note said.
Higher oil prices hurt discretionary spend when the economy is recovering from the Covid-19 shock. An increase in $10 per barrel can potentially reduce consumption by 0.4% of GDP.Indranil Sen Gupta, Aastha Gudwani, India Economists, BofA Securities
Flagging off the inflationary impact of rising crude oil prices, RBI Governor Shaktikanta Das, at the Monetary Policy Committee meet in February, called for calibrated unwinding of high indirect taxes on petrol and diesel — in a coordinated manner by the centre and states — to contain further build-up of cost-pressures in the economy.
Metals To Push Manufacturing Costs
Higher global metal prices tend to reflect in the wholesale prices of manufactured products, which rose 5.13% in January 2021 — the most since at least April 2013.
The reflation in metals will push up wholesale inflation for manufacturing products further, said Madan Sabnavis, chief economist at CARE Ratings.
While India does export steel, India is a price taker for most commodities such as aluminium, copper and zinc. As such, any rise in price is reflected in a rise in the manufacturing costs, pushing up WPI.Madan Sabnavis, Chief Economist, CARE Ratings
To be sure, the extent of pass-through of raw material prices to the cost of final goods depends on local market dynamics.
Ashima Goyal, a member of India’s Monetary Policy Committee, said pricing power with manufacturers is limited. “For the last so many years manufacturing inflation has been low in India—a factor responsible for the wide gap between WPI and CPI inflation,” she wrote in the minutes of the MPC’s February meet. “One reason is India is a very competitive price-sensitive market. Manufacturers pricing power is temporary and will not survive the full resumption of supply it will attract.”
Copper A Pain-Point
Copper, in particular, may be a pain-point for India. Copper prices have risen 86.9% on the LME since the lows of March and are trading at the highest levels since 2011.
India shall continue to be a net importer, pending the resumption of Vedanta Ltd.’s 400-kilotonnes-per-annum copper smelting facility, according to a note by CARE ratings dated Feb. 18, 2021. As such, the rise in copper prices will have implications on the electrical and telecommunication industry, followed by transport, consumer durables, building and construction, general engineering goods, the report said.
Food Prices To Remain Unaffected
While the focus is on rising oil and metal prices, global food costs have also moved higher.
The FAO Food Price Index, a measure of the monthly change in international prices of a basket of food commodities, rose 10.6% over a year ago in January 2021. It is up 19% since the lows of March.
The correlation between global and domestic food prices, however, is inexact.
According to a July 2020 research paper by the RBI, the pass through of global food transmission to domestic prices is relatively weak in the short run, but there exists a significant degree of global food price transmission to domestic prices in the long-run.
The short-run price transmission elasticity for food price was 0.07, which implied that a 10% increase in world food prices could lead to an increase of 0.7% in Indian food CPI. The long-term transmission elasticity of world food price was 0.3, which implied that a 10% increase in world food prices could lead to an increase of 3% in India.
Inflation in food items tends to be determined by local mandi prices in the short term, unless import dependency for that commodity is particularly high.Vivek Kumar, Economist, QuantEco Research
Sanguine Outlook For Local Inflation?
Despite global pressures, local inflation may remain within India’s target band of 4 (+/-2)%.
Nandi expects headline CPI inflation to average around 4.7% in 2021, primarily reacting to lower food prices. Core CPI inflation, however, is likely to remain elevated at above 5% on average, reflecting higher commodity prices, increased input costs, and gradual return of pricing power, he said.
The RBI estimates CPI inflation at 5.2% in Q4 FY21 and 5.2-5% in the first half of the next financial year, with risks broadly balanced.