India's headline inflation, typically, follows movements in food inflation, as food occupies a 39% share in the average consumer's basket. The least-bothersome component of the consumer price index (CPI) past year—food prices—is, thus, threatening to undermine the Reserve Bank of India's (RBI's) efforts to stabilise prices. Further, though the firming up of prices due to the geopolitical event may be seen as a one-time shock, one cannot discount the impact of successive shocks, especially from weather anomalies on food prices, says a report.
In the research note, CRISIL Ratings says, "So far, the RBI has already raised the policy repo rate by 90 basis points (bps) to temper inflation and anchor expectation. Studies find that the frequency of purchase of items—rather than their expenditure share—is what shapes inflation expectations. Food fits this thesis neatly. Studies also show rising prices have a stickier impact on inflation expectations than the other way around. Therefore, so long as food inflation continues to rise or remains high, it will be that much more difficult for monetary policy to anchor inflation expectations."
It also underscores the importance of deliberating the impact of climate change on inflation and on monetary policy, the rating agency says.
In five of the past 10 fiscal years, food inflation hovered between 6%-12%. In several of these instances, government intervention through the release of buffer stocks, opening up of imports, or restrictions on exports were deployed to bring food inflation under control.
"This time, however, the surge in food prices is accompanied by high fuel and core inflation, keeping inflation consistently above the RBI's target band for the past two quarters. This has put monetary policy in a quandary and made it imperative for the central bank to look closely at factors pushing up food prices," it added.
According to CRISIL, the recent rise in food inflation is mainly supply shortages-led, driven by both global (geopolitical conflicts) and domestic (impact of heat wave) factors.
Food inflation started picking up from sub-1% in September 2021 up to 7.7% in June 2022. In sync, CPI inflation rose from 4.3% to 7.0%. This fiscal so far (April-June 2022), food inflation has averaged 8%, compared with 3.8% in fiscal 2022 and 3.6% in the five years preceding the pandemic or from FY15-16 to FY19-20.
"Thus, food has become the top contributor to CPI inflation this fiscal, unlike the previous year and between fiscals 2016 and 2020, when core inflation was predominant," it says.
CRISIL expects overall CPI inflation at 6.8% and food inflation at 7% for the current fiscal. "A normal and well-distributed monsoon can help cap the upside to food inflation. But other factors such as rising input costs and global prices, and government interventions have gained importance in shaping the inflation outlook this fiscal."
According to the report, commodities are driving the price rise. Most major categories—cereals, fruits and vegetables, meat and fish, and spices—have seen a sharp rise in inflation since the fourth quarter of fiscal 2022 (see table below).
"Inflation in edible oils, pulses, and sugar has trended down. However, the combined weight of these categories is lower than that of those witnessing rising inflation. While edible oil inflation is decelerating, it remains in double digits till date, since over two years now," it points out.
An unusual heatwave between February and April 2022 impacted domestic production of cereals, vegetables and spices, such as wheat, tomatoes, mangoes, and cumin, which jacked up inflation in the first quarter of this fiscal.
In April, the average maximum temperature over northwest and central India, the regions where wheat is mostly grown, was the highest in 122 years. CRISIL's analysis found that, in addition to wheat, severe damage to yields was also caused to several field crops like groundnut and bajra, and horticultural crops like mango.
"Crop-wise, there appears to be a stronger correlation between unfavourable or unseasonal rainfall and vegetables prices inflation, especially in onions and tomatoes. In fact, the contribution of vegetable inflation to volatility in headline inflation is considerably higher than other items," the rating agency says.
Prices of several inputs used in agriculture production have risen significantly since last fiscal. The weighted average wholesale price index (WPI) of farm inputs shows a consistent rise from 9.4% in April 2021 to 28.4% in June 2022. Key commodities driving the rise are fertilisers, pesticides, diesel, cattle feed, and fodder.
While government subsidy on fertilisers eases the pain, other input costs remain elevated, the rating agency says, adding, higher transportation costs on account of rising petrol and diesel prices further exerted an all-round pressure on retail agricultural prices.
CRISIL Research's CRISFrex—a freight index—registered a 20-24% rise in freight costs for agricultural products this fiscal so far, suggesting transporters have been passing on higher diesel prices by raising freight rates.
Recent inflation data show some softening in food prices, but most of that was on account of some commodities benefiting from easing of international prices, government interventions, and receding heatwave effects.
CRISIL Ratings says, it believes that food prices could continue to stay firm this fiscal, keeping overall inflation elevated, as factors driving food prices high remain broadly unfavourable.
Pulses have seen the sharpest fall in inflation among food categories and the easing has been a result of multiple factors improving the supply situation. "First, domestic pulses production has risen since fiscal 2020, reaching a record high of 27.8 million tonne last fiscal. Second, pulses import too increased, driven by trade agreements and cuts in import duties. India remains the largest producer and consumer of pulses. Data on domestic production and international trade of pulses suggests that per capita pulses consumption continued to grow over past year (see table below)."
The Indian government has tried to ease pressure on food prices by cutting import duties on edible oils and pulses, forging trade agreements for imports of pulses, and restricting exports of wheat and sugar.
"The impact of these interventions is apparent in pulses and edible oils, where inflation has decelerated in recent months. The government has also subsidised fertilisers for farmers, which has dampened the pass-through of high international prices to end-consumers," the rating agency says.
According to CRISIL, the high cost of inputs in agriculture production like fertilisers, pesticides, animal feed and diesel is expected to maintain pressure on food inflation through this fiscal year. Despite the recent softening in international prices of several food items, they remain higher than last year and the rupee has weakened, offsetting some of the impacts of falling global prices for imported food items.
The government's targeted interventions such as restrictions on wheat exports and import duty cuts on edible oils and pulses, could mildly help dampen the pass-through of global price pressures on major imported items
"But beyond the current shock, data suggests that extreme weather events are increasingly adding uncertainty to the food price outlook. It has, therefore, become imperative for central banks, particularly inflation-targeting ones, to take heed of the increasing role of climate change and weather disruptions while forecasting inflation," CRISIL says.