India’s low July inflation print to prove ephemeral

India's headline CPI for July printed at 3.8% yoy, much lower than the market expectation of 4.4%. The sharp drop in inflation was due to food inflation (which has a weight of 45.86% in CPI) coming in at a mere 2.89% yoy. This, however, results from the base effect, as food inflation during July 2014 stood at 8.72%. Essentially, the lower inflation does not reflect a drop in prices since food prices continue to remain elevated and have actually gone up on a month-on-month basis. This is best exemplified by the vegetable price inflation data. 

As per the data, vegetable price inflation was a negative 7.9% yoy in July 2015, whereas it actually shot up by 4.3% in July 2015 compared to June 2015. The base effect will be visible for one more month (until August) before it starts to peter off. Add to that continuing uncertainty about eventual performance of monsoon and it's difficult to conclude that prices have indeed softened to levels that warrant an automatic rate cut decision by the RBI. As predicted by the IMD (Indian Meteorological Department), the recent improvement in monsoon activity did not last long. For the week ending 5 August, the country as a whole received 26% less rainfall (than normal); the Southern Peninsula continued to be the worst affected with rainfall 51% lower than normal. In fact, during the entire monsoon period to date (1 June to 5 August), the Southern Peninsula has been in the grip of drought with overall rainfall being lower by 21%. On the other hand, the states of Gujarat, West Bengal, Rajasthan and Odisha have suffered floods.

While the sowing of crops during this monsoon season has reached record levels, drought in some parts of the country and floods in other parts have led to crop damage. By the time the impact of the crop loss is felt on overall prices, the base effect will also have dissipated, leading to a potential surge in food inflation.

"We believe the next rate cut is likely to materialise by Q4 2015, though we do not rule out an earlier cut," notes Societe Generale.