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India’s December CPI inflation moderated to 5.2% yoy (DBSf: 5.2%, consensus 5.3%) from 5.5% the month before. Food and beverages inflation rose by a slower 7.7% yoy vs 8.2% in November, on a broad-based sequential decline in perishables (vegetables), cereals and pulses, while edible oils and eggs registered MoM increases. Core (ex-food and fuel) stabilised at 3.6%, backing our view that demand conditions are subdued, posing limited risk of second round effects, alongside muted manufacturing costs. Ongoing disinflation in key food categories and expectations of a strong kharif output point to January’s inflation easing further to ~4.5-4.6% yoy, suggesting 1Q25 average will stand at 4.5%, in line with the RBI’s projection.
Recent rupee depreciation and escalation in oil prices have raised concerns over pass through to price pressures. A 5% deprecation in the currency adds 0.35pp to headline inflation according to the central bank, although manufacturers are unlikely to immediately and fully pass on costs amidst the ongoing cyclical slowdown. An escalation in US-China trade skirmish will also impart a deflationary impulse as China will seek to channel more exports into this region. Risk of transmission from higher oil onto local fuel prices is limited as official preference will be to keep domestic petrol and diesel costs unchanged to preserve households’ purchasing power. The RBI monetary policy committee faces a difficult decision at the February meeting as a slowing inflation outlook is accompanied by mounting INR depreciation pressures. Anticipating higher weightage to easing inflation and a cyclical slowdown, we expect the MPC to undertake a modest cut to make policy less restrictive next month. Market players have sought the RBI’s support in easing the domestic liquidity squeeze, which failed to abate despite the largest variable rate repo auctions last week, and similar efforts in Dec24. Shorter-tenor dollar rupee swap worth $3bn was reportedly undertaken to inject INR liquidity, according to Bloomberg, but this further complicated FX management.
Much like the Asian peers, a strong dollar continues to weigh on the rupee, with the currency weakening past 86.0 to a new low yesterday. While a shift in the RBI’s tolerance is palpable, the pace of rupee decline can’t be only attributed to the change in guard at the central bank. A shift in the global environment (sharp USD rally and heightened uncertainty) has also given rise to trade-offs between managing the cost of strong intervention and its economic impact vis-à-vis easing grip on the rupee. Excessive intervention in the face of a one-sided move in the US dollar is likely to prove ineffective, instead tightening liquidity conditions (left unsterilised) and dampen growth conditions. Authorities are likely to show their hand to limit sharp swings but not turn the tide this week, as the dollar stands to gain from a firm US inflation print and resultant cautious stance from the US Fed on further rate cuts. Our revised FX forecasts were published in Monday’s Weekly note.
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