Inflation Readings: Food For Thought, But Easing Next Year

BMI View: The two emerging Asia giants of China and India are experiencing a re-acceleration of inflationary pressures, led in both cases by a surge in food prices. While such concerns may convince Indian policymakers to hike rates once more, this is not our core view, and the prospects of a similar move in China are slim. Instead, we maintain our long-held view that both countries will look to loosen monetary policy in 2014.

China and India, emerging Asia's two heavyweight economies, are both experiencing a re-acceleration of inflationary pressures. China's consumer price index (CPI) increased by 3.1% year-on-year (y-o-y) in September, marking the fastest pace of price growth in seven months. In India, meanwhile, the benchmark wholesale price index (WPI) rose by 6.5% y-o-y, the fifth consecutive month of accelerating headline inflation and, as in China's case, the fastest on record since February. At a time when economic growth remains in a relatively soft patch for both countries, the re-emergence of price pressures poses something of a headache for policymakers.

While inflation concerns may convince Indian policymakers to hike rates once more, this is not our core view. Newly-appointed Reserve Bank of India (RBI) Governor Raghuram Rajan displayed his hawkish credentials in September by hiking the country's repo rate by 25 basis points (bps) to 7.50% and he is likely to keep policy tight over the coming months. The recent WPI run-up means that we cannot rule out one more 25bps hike by end-2013. Still, this is not our core scenario. Firstly, macroeconomic stability in India has improved, as evidenced by the Indian rupee regaining some poise and the trade deficit narrowing sharply. Secondly (and related to the first point), India's economy remains in pretty poor shape, with industrial production growth crawling along at a snail's pace ( see 'Industrial Production Malaise To Continue', October 14). Thirdly, we are not seeing a broad-based build-up of inflationary pressures. As the accompanying chart shows, core WPI is exhibiting mild price growth, at just 2.0% y-o-y in September. Instead, it is a number of food price items that are skewing the headline number, with onion prices (up an astonishing 322.9% y-o-y in September) chiefly to blame. Our agribusiness team sees the run-up in food prices as a temporary phenomenon, with the good monsoon crop likely to trigger a price reversion before long ( see 'Asia Food Price Inflation Easing In Coming Quarters', September 24).

A Headache For Policymakers
India & China Headline Inflation, % chg y-o-y

BMI View: The two emerging Asia giants of China and India are experiencing a re-acceleration of inflationary pressures, led in both cases by a surge in food prices. While such concerns may convince Indian policymakers to hike rates once more, this is not our core view, and the prospects of a similar move in China are slim. Instead, we maintain our long-held view that both countries will look to loosen monetary policy in 2014.

China and India, emerging Asia's two heavyweight economies, are both experiencing a re-acceleration of inflationary pressures. China's consumer price index (CPI) increased by 3.1% year-on-year (y-o-y) in September, marking the fastest pace of price growth in seven months. In India, meanwhile, the benchmark wholesale price index (WPI) rose by 6.5% y-o-y, the fifth consecutive month of accelerating headline inflation and, as in China's case, the fastest on record since February. At a time when economic growth remains in a relatively soft patch for both countries, the re-emergence of price pressures poses something of a headache for policymakers.

A Headache For Policymakers
India & China Headline Inflation, % chg y-o-y

While inflation concerns may convince Indian policymakers to hike rates once more, this is not our core view. Newly-appointed Reserve Bank of India (RBI) Governor Raghuram Rajan displayed his hawkish credentials in September by hiking the country's repo rate by 25 basis points (bps) to 7.50% and he is likely to keep policy tight over the coming months. The recent WPI run-up means that we cannot rule out one more 25bps hike by end-2013. Still, this is not our core scenario. Firstly, macroeconomic stability in India has improved, as evidenced by the Indian rupee regaining some poise and the trade deficit narrowing sharply. Secondly (and related to the first point), India's economy remains in pretty poor shape, with industrial production growth crawling along at a snail's pace ( see 'Industrial Production Malaise To Continue', October 14). Thirdly, we are not seeing a broad-based build-up of inflationary pressures. As the accompanying chart shows, core WPI is exhibiting mild price growth, at just 2.0% y-o-y in September. Instead, it is a number of food price items that are skewing the headline number, with onion prices (up an astonishing 322.9% y-o-y in September) chiefly to blame. Our agribusiness team sees the run-up in food prices as a temporary phenomenon, with the good monsoon crop likely to trigger a price reversion before long ( see 'Asia Food Price Inflation Easing In Coming Quarters', September 24).

Eye-Watering Surge In Onion Prices
India - Wholesale Price Index Sub-Components, % chg y-o-y

The prospects of a near-term rate hike in China are slim. China's consumer price dynamics are similar to India's, with food price inflation (at 6.1% y-o-y in September) the main driver of headline price growth. This again should prove temporary, and with the authorities still focused on rejuvenating economic activity amid recent disappointments in purchasing managers' index readings and export earnings, a rate hike would appear to undermine Beijing's stimulus efforts.

Easing Ahead
China 1-Year Interest Rate Swap & India 1-Year OIS, %

We maintain our baseline scenario of both countries loosening monetary policy next year. We fleshed out our views on India's monetary policy trajectory recently ( see ' External Adjustment To Pave Way For Rate Cuts In 2014', October 10). In a nutshell, we believe that the RBI will turn its attention back to reigniting investment activity early next year, with one 25bps cut in the repo rate by end-FY2013/14 (April-March) to 7.25% and scope for additional easing thereafter. In China's case, lower nominal rates mean that an extended rate cutting cycle is unlikely, but we still expect one 25bps cut to the 1-year lending rate to 5.75% by end-2014. The markets appear to agree with us. In line with our expectations, short-term rates in India have come in significantly, with the 1-Year overnight index swap (OIS) rate having fallen almost 200bps since its August high. Meanwhile, the 1-Year swap chart in China has taken out key near-term resistance, opening the door to further narrowing in the coming weeks.

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This article is tagged to:
Sector: Country Risk
Geography: Asia, China, India
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