The inflation data for July showed that the Consumer Price Index (CPI) has moved up by 4.17 per cent year-on-year (YoY) versus July 2017. This is lower than the 4.92 per cent YoY change for June 2018. If inflation is moderating, there are good chances that the RBI will not hike rates in its next policy review. That’s good for the financial sector, and for businesses that are capital-intensive.
However, the ‘headline’ overall number is deceptively low. Food is a key component of the CPI basket, with a weight of around 45 per cent. Food inflation is down, to 1.7 per cent YoY and that’s the major reason for overall CPI staying low.
Food is a volatile component due to seasonal price-variations. The other volatile component of the CPI is fuel, which has a 7 per cent weight in the index. Fuel inflation is at a high of 8 per cent YoY. Again, fuel is volatile because it’s dependent on crude and gas prices and those prices change daily.
Most economic analysts also examine the ‘non-volatile’ elements of the CPI, where changes in trend are ‘sticky’. Those elements are together known as core inflation. Housing with 10 per cent weight is the largest core component, while transport is at 9 per cent, healthcare is at 6 per cent, clothes 5.5 per cent, education 4.5 per cent, etc. These items are, by and large, not very volatile. But once they go up, they tend to stay up permanently.
The worrying factor is that every core item with a large weight is at a 12-month high in terms of YoY changes. Transport is at 6.6 per cent, housing is at 8.3 per cent, education is at 5.8 per cent, healthcare at 5.8 per cent, etc. Overall, core CPI is running at above 6 per cent and that is a four-year high. Inflation trackers flagged the uptrend of high core inflation several months ago, and true to definition, once that trend has been established, it has run higher with no sign of moderation.
A weaker currency will mean more inflation going forward. Apart from fuels and gold, India also imports other stuff. However, quite importantly, many Indian imports are from other third-world nations where there may have been even more currency depreciation, compared to the rupee. While most imports are dollar-denominated, this could mean that imports other than fuel are priced cheaply, even though the rupee has fallen.
One sector, which could be under the gun, is the domestic steel industry. This may have interesting repercussions. India is one of the world’s three largest producers of steel, with production of around 101 million tonnes (MT) in 2017. China dwarfs India with over 830 MT of production and Japan (world number two) has slightly more capacity at around 105 MT. The US is fourth with 82 MT. India exported 16 MT in 2017 and imported around 9 MT (in different categories). India exports more steel when global prices are high but it is hit by imports when prices are low.
Higher construction activity means larger steel demand and there are hopes of construction picking up. The government has been offering tariff protection against steel imports with high customs duties but if global prices fall, the landed price of imports could drop below the domestic cost of steel production.
Steel has been a major contributor to bank non-performing asset (NPA) and a price recovery has been a major source of relief to the financial sector. Higher prices have allowed loss-making companies to return to the black and it has allowed banks to look for settlements under the Insolvency and Bankruptcy Code. Bluntly put, if steel prices are low, there are few takers for a bankrupt steel producer, even if it’s placed on the block at a deep discount.
China, Russia, Ukraine and Japan are four major steel exporters. Russia and Ukraine have seen currency depreciation of 15-20 per cent in calendar 2018, while the yuan has depreciated more than the rupee. The domestic steel industry could come under pressure from cheap imports.
Of course, this might be useful for the construction industry’s margins but it will make it harder for the banks to handle NPA recovery. The steel industry will be worth tracking carefully through 2018-19 since it will provide hints for the direction of construction and finance.