India has managed to buck the global inflationary tide so far, with wholesale prices declining for six straight months. But this deflationary trend could prove short-lived if crude oil prices see a sustained spike over the coming months, raising the stakes for the ruling party at the Center.
With no end in sight to the Russia-Ukraine war, the risk of supply disruptions and elevated crude prices persists. This is an area of concern for India, which relies on imported oil to meet 85% of its energy needs.
Production Cuts & Crude Price Risk
Crude oil prices have cooled off considerably from their mid-2022 peaks, a key factor behind India’s wholesale price deflation. However, the OPEC+ decision in early October last year and April this year to cut oil production by 2.5 million barrels per day has again pushed up crude prices.
“This month’s report clearly shows that the inflationary pressure caused by high food prices has eased down considerably – which clearly indicates a good sign for the market,” said Centrum Broking in its report on the September WPI or wholesale price index reading. “However, production cut done by Saudi Arabia and Russia could hurt the prices further on the upside,” it warned.
Crude prices have been on the up since May, from around $70 per barrel to around $90 now.
With the Russia-Ukraine war and tensions in the Middle East around Ukraine, the threat of a larger supply shock can’t be ruled out either. This poses a serious upside risk to crude prices. Any such spikes will feed directly into higher inflation for India via costlier imports.
Imported Inflation Key Driver of WPI
Imported finished goods and inputs play a sizable role in India’s wholesale price inflation. International commodity prices directly impact prices of imported items, as seen in the September report. “..the slower contraction in WPI is mainly led by a recovery in imported inflation (largely crude oil & natural gas prices), which rose 10.3% MoM during the month – the highest sequential growth in 11 months,” highlighted Motilal Oswal.
Besides finished goods, crude oil is a critical input for sectors like chemicals, paints, plastic products and pharmaceuticals. Higher crude-derived input costs will ultimately get passed through to wholesale prices. The lagged effect of the past rise in oil prices is still feeding into the WPI pipeline.
The spike in natural gas prices globally has also inflated India’s import bills. Petroleum products alone accounted for 8% of India’s total imports last fiscal. With the import intensity unlikely to change dramatically in the near term, India remains vulnerable to external crude price shocks.
Currency Depreciation
India’s import costs have also shot up due to the weakening of the rupee against the US dollar in 2022. The Indian rupee has depreciated nearly 10% against the greenback in the last two years, and is hovering near record lows.
Currency depreciation inflates the rupee cost of dollar-denominated crude oil and other imports. This currency effect will further cascade through India’s supply chains and lift wholesale prices.
“Moreover, the lagged impact of currency depreciation is yet to fully pass through,” highlighted Motilal Oswal. As the effect of higher import costs spreads, it could outweigh the tailwind of easing commodity prices.
Food, Wage Pressures May Persist
While high food inflation has moderated lately due to a good monsoon, price risks remain due to uneven rainfall distribution. Cereal inflation continues to remain elevated, signaling the uneven impact of rains. Moreover, rural wage growth has accelerated to 3.4% as per the latest data. India is expected to see the impact of patchy rainfall in food prices soon.
Rising rural incomes will support demand and add to underlying inflationary pressures. “Rising rural wages amid tightening labor market conditions could also feed into higher core inflation eventually,” noted Motilal Oswal.
India’s services inflation also remains stubbornly high as companies pass on higher input costs. The transmission of input price pressures to consumers is incomplete and could continue.
Taming Inflation Critical for RBI
With risks tilted towards higher WPI inflation, the RBI will have its task cut out. “If this scenario materializes, our non-consensus prediction of ~7.8% nominal GDP growth would become a reality, notwithstanding the upward revision in the real GDP growth,” reckoned Motilal Oswal.
The RBI’s current priority is to ensure that inflation remains contained without hurting growth prospects. But if oil and food prices rise again or the currency weakens further, the RBI may be forced to consider further rate hikes.
This delicate balancing act between supporting growth and taming inflation will define India’s monetary policy outlook. While deflationary forces have provided temporary respite, RBI’s inflation fight is far from over.
India’s wholesale inflation outlook will depend on how oil and commodity prices as well as currency movements play out. Given India’s dependence on imported energy, a sustained rise in crude prices poses an upside risk to inflation.