Soft inflation is not transitory

India's consumer price index (CPI) inflation dropped to a 59-month low of 3.5 per cent yearon-year (y-o-y) in July.

Yet, this did not lead to any celebrations. The reasoning, according to the consensus view, is that the drop in inflation is due to base effects and that risks related to food inflation are tilted to the upside. Therefore, monetary policy cannot let its guard down, especially as growth is strong and there is a need to lower credit growth and narrow the credit-deposit growth gap.

We would push back against this consensus view for the following reasons.

This is not just base effects: Base effects did play a role, but they were well known, so the downside surprise in the July CPI implies weaker-than-expected momentum. July saw a steep upward revision in mobile tariffs; yet the sequential momentum for core inflation rose at the same pace as in June, meaning that inflation in most other core categories remained benign.

Food inflation is not a big risk: Food prices are volatile and hard to predict, but high frequency data shows that prices are cooling or will cool soon. Nearly 50 per cent of food inflation so far in 2024 has been led by vegetables, which have shorter price cycles. With fresh arrivals increasing, vegetable prices are already lower in August. Pulses follow a cobweb cycle, where higher price incentivises more sowing, leading to higher output and low prices - a trend underway for tur dal. Above-normal rains in the rest of the kharif season and higher reservoir levels are likely to help cool rice and wheat prices.