A statistical illusion? How India’s inflation fell to a 5-year low in July

After nearly five years, India’s retail inflation dipped below the Reserve Bank of India’s medium-term target of 4% in July, recording 3.54%, down from 5.08% in the previous month. Food inflation also saw a sharp decline, dropping to 5.42% from 9.36% in June. 

While this decrease may be temporary due to the statistical impact of a high base (inflation in July 2023 had surged to 7.44%), a genuine easing in food prices is anticipated in the coming months, potentially leading to a more lasting decline in inflation. 

Mint breaks down the July inflation data and the outlook:

Statistical illusion

Despite the sharp drop in July, the fall in retail inflation was largely due to the base effect, as price pressures actually increased compared to the previous month. The overall consumer-price index (CPI) rose 1.42% month-on-month in July, marking the biggest surge in a year. 

This was driven by a 2.47% increase in the food and beverages price index, a 0.5% rise in the housing index, and a 0.77% increase in the miscellaneous index. This indicates that household budgets were more strained than in June. 

However, since the index had expanded even more last July (2.93%), the year-on-year inflation rate appeared lower. 

Read this | Why food inflation cannot be excluded from target inflation

Vegetables remain a pain point. Following their seasonal trend of rising prices during summer, the index climbed 14.13% month-on-month, but due to the base effect, vegetable inflation sharply dropped to 6.83% in July from 29.32% in June.

Power play

Volatility in vegetable prices has a strong influence on headline inflation. When vegetable prices surge due to seasonality or low supply, headline inflation spikes; conversely, when prices correct or supply increases, headline inflation declines sharply. 

In recent months, vegetable prices have kept inflation elevated. If vegetables were excluded from the overall retail basket, inflation would have remained below 4% every month since December. 

Tomatoes, which have a minimal weight of just 0.57% in India's retail inflation basket, significantly impacted headline inflation in July, pulling it down by nearly 90 basis points due to a 42.91% deflation, compared to a 26.51% inflation in June. 

If not for tomatoes, inflation would have been 4.4% in July. 

But again, base effect was at play. Tomato prices actually rose 41% sequentially; they were just too high in July 2023.

Cost of communication

Early in July, India’s two biggest telecom players—Reliance Jio and Bharti Airtel—hiked their tariffs. As a result, inflation for mobile charges surged to 8.9% in July from 1.01% the previous month, recording such steep inflation after a gap of two years. This became one of the biggest pain points in July, even as the overall number masked the underlying price pressures. 

According to Nomura, the telecom tariff hike added 0.15 basis points to headline inflation and 0.31 basis points to core inflation (this refers to the build-up of the 3.54% overall inflation rate; a one-basis-point contribution refers to 0.01%). 

Once tariffs are hiked, they usually stay at the same level for some time, which means their impact on inflation is likely to stay until June 2025. With some hikes being delayed to August, a part of it could also be seen during the month, said Emkay Global Financial Services in a note.

Food fury

Elevated food prices, along with volatility in vegetable prices, have added uncertainty to the trajectory of headline inflation. This is one of the reasons the central bank hasn’t moved to cut interest rates yet and is keeping a close eye on the movement in food prices. With almost a 40% weight in the inflation basket, food is the biggest component and tends to influence headline inflation strongly. 

In the past year, the dominance of food has increased on the headline inflation: in September 2023, food and non-food items had somewhat equal contributions to overall inflation but food’s contribution has increased to 60-70% since November. 

The decline in July was mainly due to food inflation as the contribution of non-food items has remained steady in recent months. 

As such, the movement in food prices in the coming months will play a crucial role in the inflation trajectory even as it is expected to average 4.4% in July-September and 4.7% in October-December.

Rainfall relief

The Reserve Bank of India (RBI) is keeping a close eye on food prices, which have been elevated for a year due to low production. However, despite a tepid start in June, the monsoon picked up pace in July, which bodes well for food production and inflation trajectory. 

Also read | Raghuram Rajan: Brace for stronger inflation and possibly weaker central banks

An analysis by India Ratings and Research, which tracked how much rainfall a particular crop has received this year based on their state-wise production patterns, showed that rainfall for pulses and oilseeds was 15% and 16.5% higher than the normal, respectively, as of 2 August. While rainfall for rice was 0.1% lower than normal as of 2 August, the situation significantly improved compared to the last two months.

While the fading base effect after August could push inflation higher, increased food production could counterbalance this, potentially pulling inflation lower in the future.

Payal Bhattacharya contributed to this story.