The last one year has been a time where the inflation in India has surprised on the upside on a consistent basis. The initial push for the inflation came from food prices as we had a poor monsoon season which resulted in runaway inflation in a large number of key commodities like pulses, sugar, milk and milk products etc. This was followed by the rising commodity prices globally where we saw crude oil, metals and other global commodities rally sharply from the lows of early 2009. Along with a pickup in consumption there was a significant restocking cycle as credit availability improved and most consumers became confident of recovery. The last factor that came in specific to India was the phenomenon of capacity constraints in a large number of industries as a result of a V shaped recovery in the economy which led to a vast majority of producers enjoying pricing power to push the input prices hikes to the consumers. This also got combined with the increase in Excise duties in the Union Budget, where as a direct pass on prices of most products were raised upwards by 2% on an average.
However headline inflation now seems to have clearly peaked out with the June inflation figure most likely to be the peak for the foreseeable future. Over the last several weeks, despite the hike in fuel prices the Wholesale price index has been more or less been in a range. This is specially true of food inflation where the index has moved up from 296.4 at May end to 298.3 last week, i.e. a rise of 0.64% over a two and a half month period. Ex of fuel inflation the overall WPI has also risen by just around 1% in the same time period. Given that we are now entering into a phase over the next few weeks where inflation shot up sharply last year the base effect will also play out and lead the headline inflation lower.
Even ex of the base effect, an excellent monsoon season in India will lead to food prices being subdued and given that the rains have been extremely good at places where reservoirs are situated the storage situation of water in these places is also reaching levels where we are likely to have a situation where water supply will not be a constraint for the next couple of years. On top of that we also have forecasts that the current La Nina conditions should continue till the beginning of 2012, which implies that we are likely to have a good monsoon season next year also. ( These forecasts keep on changing so it might be difficult to bet on it)
The other factor which is more important is that given the uncertainties on global growth we have seen global commodity prices come off sharply. Crude oil prices today are flat vis a vis what they were 12 months back. Steel prices have come off sharply over the last four months are likely to remain subdued for at least the next 3-4 months. Most base metal prices have seen corrections and are likely to trade in a range going forward. The growth forecasts for the USA and EU have been steadily downgraded over the last 3 months and in general the OECD growth indicators have been showing that growth in the developed world has started flattening. The sharp rally in the US Treasuries and German Bunds is also a reflection of flight to safety and fears of prolonged below par growth. I personally find US Treasuries and Bunds to be heavily overbought and overvalued.
Chinese growth is also likely to slowdown with the clampdown on easy money in that country, however that country remains difficult to call as the sustained growth in China keeps on surprising everyone quarter on quarter. Given the extreme export dependence of that economy it will be difficult for the historic growth trends to sustain going forward.
As such looking at the overall global economic picture and the monsoons the inflationary pressures on the economy are likely to fall off sharply over the next six months. The significant tightening by the RBI and the sucking out of liquidity due to CRR hikes and Telecom auction outflows has also led to a moderation of demand led inflation. As inflation falls more than expectations the pressure on RBI to tighten aggressively will also reduce & this will be positive for long term sustainable growth of 8-9%.
Too many commentators have started talking about markets doing well in the short run while being apprehensive about the long run. I would rather be skeptical on the short run and very confident on the long run.