Next Phase of India’s Inflation Cycle May Already Be Taking Shape: Crisil Economist

Consumer price inflation (CPI) has edged closer to 5% and, according to the projections of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), is likely to move nearer the upper tolerance limit of 6% in the December quarter.

Price pressures higher up the supply chain are even more pronounced. Wholesale price inflation accelerated to 9.9% in August from 4.0% in March. Over the same period, CPI inflation increased from 3.4% to 4.8%.

The widening gap between wholesale and retail inflation suggests that rising input costs have yet to be fully transmitted to consumers. This is also evident in the output price index, based on the basic prices of manufacturers, excluding net taxes and transport margins, which nearly doubled to 9.8% in August from 4.2% in March.

Pressure Building

The West Asia conflict, initially expected to last no more than a quarter or two, has persisted longer than anticipated. As pressures on energy and other critical inputs have intensified, producer-level inflation has accelerated more rapidly than consumer inflation.

Meanwhile, retail price pressures have remained relatively contained. Fuel price increases have been gradual, businesses have been cautious in passing on higher costs, and last year’s goods and services tax rate rationalisation continues to moderate headline inflation.

However, underlying inflationary pressures are steadily building.

Apart from the prolonged conflict in West Asia, monsoon-related risks to food prices are beginning to materialise. At the same time, the rupee has so far weakened 11% on-year this fiscal, raising import costs and adding another layer of inflationary pressure.

Robust domestic demand conditions are also creating greater scope for cost pass-through, although pockets of demand fragility remain. With all-India rainfall deficiency reported at 15% this season, weaker agricultural yields and lower farm incomes could dampen rural demand.

However, fiscal support measures, including state cash transfers, income support under Pradhan Mantri Kisan Samman Nidhi, and the free foodgrain programme under Pradhan Mantri Garib Kalyan Anna Yojana, should help cushion the impact.

Inflation Cycle Begins to Kick In

A closer examination of inflation trends reveals three important developments.

First, food inflation is beginning to regain momentum. CPI food inflation rose to 6% in August, driven largely by sugar, prepared food, and eggs, meat and fish. A weaker monsoon poses further upside risks through its impact on crop yields.

That said, the transmission of weather shocks to food inflation has weakened over time because of active government intervention through the release of food stocks and adjustments to agricultural trade policies when domestic prices rise sharply. As a result, while food inflation is likely to remain elevated, the upside risk may be more contained than historical experience would suggest.

Second, fuel price pressures are becoming increasingly visible. Unlike several Asian peers, India has absorbed a significant share of the global fuel price shock through lower margins for oil marketing companies, a higher fiscal burden, and measured adjustments in retail fuel prices. As a result, despite a nearly 65% increase in crude prices for the Indian basket since the onset of the conflict, retail petrol and diesel prices have risen by only about ₹7.5 per litre.

Although fuel inflation has moderated after the initial spike in June, underlying pressures remain substantial. With crude prices staying above $100 per barrel, further increases in domestic fuel prices cannot be ruled out.

The impact extends well beyond the fuel basket. Fuel costs feed into inflation through transportation, an important transmission channel for overall prices. Road freight remains the dominant mode of goods movement in India, and fuel accounts for roughly two-fifths of operating costs. Consequently, higher fuel prices can ripple through supply chains via rising logistics costs, adding to both food and non-food inflation.

Third, core inflation is beginning to reflect the cumulative impact of cost pressures. After remaining relatively benign during the early part of the fiscal, core inflation, a measure closely tracked by central banks to gauge underlying demand-side pressures, is showing signs of firming up. Much of the softness so far reflected GST rate reductions implemented last year.

Core inflation, measured as headline inflation excluding food and fuel, rose to 4.2% in August after remaining stable at 3.9% for three consecutive months. This measure accounts for more than half of the CPI basket. Excluding gold and silver, core inflation was lower at 2.9%, but the increase was steeper than in previous months. Importantly, the rise was broad-based across categories.

The next phase of India’s inflation cycle may already be taking shape.

Challenge for the RBI

Retail inflation is expected to rise in the coming months, driven by an unfavourable base effect for food inflation, higher edible oil prices, the fading impact of GST rate rationalisation, and a gradual pass-through of input costs, particularly transportation expenses.

The comparison with last fiscal is particularly striking. Headline CPI inflation averaged a record low of 2% this fiscal. A rebound from those levels was always expected. However, as the fiscal progresses, upside risks are growing. Crisil expects CPI inflation to average 5.1% this fiscal, with risks tilted to the upside.

For monetary policy, inflation remains the dominant risk requiring close monitoring and potentially decisive policy action. We expect the MPC to raise the repo rate by 25 basis points towards the end of the fiscal, although the timing will depend on incoming inflation data.

Yet inflation management is not the only challenge confronting Mint Road.

The banking system continues to grapple with abundant liquidity following strong inflows from foreign currency non-resident deposits. Although the RBI has undertaken a series of measures to absorb surplus liquidity, system liquidity remains elevated and short-term rates continue to trade soft. In contrast, long-term bond yields have firmed, reflecting rising inflation and policy rate expectations, elevated oil prices, and higher global sovereign yields.

The RBI is therefore navigating an increasingly delicate balancing act: normalising surplus liquidity, preventing inflationary pressures from becoming broad-based and persistent, and ensuring an orderly adjustment in bond yields. How effectively it manages these competing objectives will likely shape the next phase of monetary policy.

The author is principal economist and senior director at Crisil Limited. Views expressed are personal.