The investment bank said despite its core inflation forecast for India remaining unchanged, it maintains the base case of a shallow rate cut cycle from Jan-March 2024. It also expects the recent trend in inflation to undergo broad-based moderation, and the possibility of a delayed start in the rate-cut cycle.

In a report titled ‘Assessing Risks to Inflation Trajectory’, Morgan Stanley said it expects India’s CPI during July to be around 6.2-6.4%.

“The upside is primarily being driven by (an) increase in food inflation, mainly reflecting higher inflation in vegetables and somewhat in pulses and cereals. We expect core inflation to remain unchanged and largely range-bound around 5.0-5.2%,” the report said. “Beyond QE (quarter ending) Sep-23, we expect inflation to track between 5-6%, driven by changes in food inflation. Indeed, vegetable prices tend to be volatile with a short cropping cycle and can potentially correct swiftly.”

Food inflation, accounting for a sizeable 39% of CPI, is showing signs of pressure due to extreme weather events, domestic policy and geopolitical developments. Food inflation can be high even when the monsoon is normal, according to another report by rating agency Crisil.

Monsoon has swung from deficit in June to normal in July, bringing spells of excess rain for major crop-producing states. The current risk emanates from excess-rain-led damage to vegetables and crops in the well-irrigated northern and western India.

“El Niño’s impact has not been visible yet, and past data show not all El Niño years are associated with high food inflation. However, it is a global risk that could hit international production and prices of commodities such as rice and edible oils,” according to Dharmakirti Joshi, chief economist at Crisil.

The concern on food inflation is evident in the pre-emptive steps the government is taking, such as banning some types of rice exports, imposing stocking limits on wheat, and market intervention to improve supplies. “Trade restrictions on agriculture remain a risk for international food prices, with countries focusing on ensuring domestic food security,” CRISIL economist said.

India – the largest exporter of rice and second largest of sugar – has imposed a ban on exports of broken rice and continues curbs on wheat and sugar for ensuring its food security. Russia pulling out of the Black Sea grain deal has also raised inflationary risks since Russia and Ukraine are the world’s largest suppliers of wheat and sunflower oil.

Morgan Stanley now expects inflation during FY24 to average at 5.4%, against the previous estimate of 5.2%.

India’s retail inflation, which cooled steadily for four months, leapt to a higher-than-expected 4.81% in June, driven by rising food and vegetable prices.

However, June’s retail inflation remains within the central bank’s upper tolerance band of 6%, but above the 4% medium-term target.

Food inflation measured by the Consumer Food Price Index (CFPI), which accounts for nearly half of the overall consumer price basket, rose to 4.49% in June 2023 against 2.96% (revised) in May 2023. Other economists have also cautioned that inflation could cross 5% in the next two months on a continued rise in prices of vegetables, pulses and cereals.

“Even as we expect headline inflation to track somewhat higher than our previous expectation, we believe that the underlying trend in inflation remains unchanged, as reflected in core inflation forecasts,” the Morgan Stanley report said.

“As such, we maintain our base case of a shallow rate cutting cycle from 1QCY24. Risks of a delayed start to the rate cutting cycle could emerge if the trailing (i.e., headline) inflation in QE Dec-23 remains above 6% (our current forecast is 5.7%),” it added.

The report said that key risks in the near-term stem from volatility in food inflation and changes in global commodity prices.

“While these risks remain cyclical, risks to core inflation pressures stemming from faster-than-expected domestic demand conditions can change the underlying inflation trajectory,” it added. (ENDS)

Updated: 02 Aug 2023, 09:36 PM IST